Australian master financial planning guide 2020/21. [23rd edition.] 9781922347398, 1922347396

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Disclaimer No person should rely on the contents of this publication without first obtaining advice from a qualified professional person. This publication is sold on the terms and understanding that: (1) the authors, consultants and editors are not responsible for the results of any actions taken on the basis of information in this publication, nor for any error in or omission from this publication, and (2) the publisher is not engaged in rendering legal, accounting, professional or other advice or services. The publisher, and the authors, consultants and editors, expressly disclaim all and any liability and responsibility to any person, whether a purchaser or reader of this publication or not, in respect of anything, and of the consequences of anything, done or omitted to be done by any such person in reliance, whether wholly or partially, upon the whole or any part of the contents of this publication. Without limiting the generality of the above, no author, consultant or editor shall have any responsibility for any act or omission of any other author, consultant or editor.

About Wolters Kluwer Wolters Kluwer is a leading provider of accurate, authoritative and timely information services for professionals across the globe. We create value by combining information, deep expertise, and technology to provide our customers with solutions that improve their quality and effectiveness. Professionals turn to us when they need actionable information to better serve their clients. With the integrity and accuracy of over 45 years’ experience in Australia and New Zealand, and over 175 years internationally, Wolters Kluwer is lifting the standard in software, knowledge, tools and education. Wolters Kluwer — When you have to be right. Enquiries are welcome on 1300 300 224. ISBN 978-1-9223-4739-8 © 2020 CCH Australia Limited First published.................................... September 1998

13th edition.................................... August 2010

2nd edition.................................... August 1999

14th edition.................................... August 2011

3rd edition.................................... July 2000

15th edition.................................... August 2012

4th edition.................................... September 2001

16th edition.................................... August 2013

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17th edition.................................... August 2014

6th edition.................................... July 2003

18th edition.................................... September 2015

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11th edition.................................... August 2008

23rd edition .................................... September 2020

12th edition.................................... August 2009 All rights reserved. No part of this work covered by copyright may be reproduced or copied in any form or by any means (graphic, electronic or mechanical, including photocopying, recording, recording taping, or information retrieval systems) without the written permission of the publisher.

Foreword The Wolters Kluwer Australian Master Financial Planning Guide is Australia’s leading publication on financial planning topics. This 23rd edition of the Guide maintains its straightforward, practical style, and includes many case studies and examples. The financial planning industry continues to undergo change as it grapples with the recommendations of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services industry and the challenges of the COVID-19 pandemic. As always, financial advisers have an important role to play in guiding their clients through the constant change and to help them achieve their financial objectives. The Guide is an invaluable resource to help advisers and other financial planning professionals navigate the changes. The Guide has been updated for all financial planning developments which take effect from 1 July 2020. To keep up to date with financial planning developments throughout the year, Wolters Kluwer offers the Financial Planning Navigator. The Financial Planning Navigator is an online, searchable subscription product and is based on the content of the Guide. It is updated on a regular basis throughout the year. The Guide has been updated by a wide range of experts from both industry and academia. Wolters Kluwer thanks the valued team of authors for their contributions. For a detailed list of all the changes included in this edition of the Guide, see the “What’s New in the 2020/21 Guide” on page xiii. Wolters Kluwer Acknowledgments Wolters Kluwer wishes to thank the valued team of authors for their contributions and the following people who supported this publication. Director, General Manager, Research & Learning, Wolters Kluwer Asia Pacific — Lauren Ma Associate Director and Head of Content, Wolters Kluwer Asia Pacific — Diana Winfield Books Coordinator, Wolters Kluwer Asia Pacific — Jackie White Senior Production Specialist, Wolters Kluwer Asia Pacific — Alexandra Gonzalez

About the Authors Louise Biti, MTax, BEc, BA(AS), Dip FP, CFP, SSA, CTA, Co-founder and Director of Aged Care Steps, has been providing technical analysis and support in relation to legislative issues and financial planning strategies to advice professionals for over 25 years. She has broad experience across taxation, superannuation, aged care, estate planning and social security legislation and is one of the pre-eminent experts in aged care. She is the author of Don’t Panic: Age the way you want, where you want. Louise is a previous Director of the Financial Planning Association and SMSF Association boards and has been awarded the FPA’s Distinguished Service award. Currently, she is a member of the Aged Care Financing Authority. Louise is a regular speaker at industry conferences and is often quoted in the media.

Jennifer Brookhouse, BComm, Diploma of Financial Planning, is Senior Technical Consultant with NAB at MLC Technical Services. Prior to this role, she was Head of Technical Services for Zurich Financial Services and National Technical Manager at ING. In both these roles, she was responsible for the analysis and interpretation of technical issues relating to superannuation, social security and taxation legislation. Gaibrielle Cleary, BEc, LLB, LLM, is the Tax Partner at Mazars. Gaibrielle practises in all areas of direct and indirect taxation. Previously, she was the in-house counsel for an ASX-listed company and has practised at leading international law and accounting firms. She is one of the authors of Wolters Kluwer’s Small Business Tax Concessions Guide, and has also written for a number of taxation publications, including Wolters Kluwer’s Australian Federal Tax Reporter. Graeme Colley, CA SSA, teaches as an adjunct lecturer at the UNSW and WSU in taxation, superannuation and self managed superannuation funds to post-graduate students. He has also held positions with the SMSF Association as Head of Technical and Professional Standards, National Technical Manager with ING and also has considerable superannuation experience with the ATO. Kim Guest is a Senior Technical Manager at FirstTech. Kim joined FirstTech, the Colonial First State technical team in May 2012. Prior to joining FirstTech, Kim was the Technical Services Manager at Count Financial. Kim has over 16 years’ experience in the financial planning industry, holding several roles including Technical Analyst, Business Analyst and Paraplanner. Kim also has significant experience with Centrelink and aged care having worked as a Financial Information Service Officer and Policy Officer in the Financial Industry Network Support Unit of Centrelink. Kim provides technical information and strategy advice on a range of areas specialising in social security, aged care and superannuation. Kim holds a Bachelor of Economics and a Diploma of Financial Planning. Loretta Iskra, AFP®, MFin-Res, MFP, BCom, DipFP, AdvDipAcctg is a Lecturer at the University of Wollongong. She has been involved in the finance industry for over 20 years. Loretta was a Certified Financial Planner (CFP®) working in practice, prior to moving to higher education in 2007. Loretta combines her unique practitioner expertise to develop her research and teaching priorities, contributing to the areas of financial planning, superannuation, retirement planning, financial literacy and work-integrated learning. Loretta is also a member of the Financial Planning Academics Forum, a specialist group that aims to develop research and teaching strategic objectives for financial planning. Currently, she is involved in research projects examining Australian baby boomers and retirement income policy, and the effects of COVID-19 on the uptake of digital advice. Loretta provides media commentary on areas associated with superannuation, baby boomers and retirement. James Leow, LLB (Hons), MTax (UNSW), is a tax and superannuation writer. He is co-author of the Wolters Kluwer Master Superannuation Guide and also writes for a number of other Wolters Kluwer publications. Craig Meldrum, MTax, BBus, Dip FP, SF Fin, FFPA, AFA, SSA, CTA, is the Head of Professional Standards & Technical Services at Infocus Securities Australian Pty Ltd. Craig is a Registered Tax Agent and is qualified in business with specialist expertise in financial services regulation and compliance, taxation and superannuation. Craig has over 30 years’ experience in banking and financial services and over the last 16 years has combined executive management with compliance, risk management and technical services to provide accountants, financial planners and risk specialists with leadership and guidance in the changing world of professional advisory. He is a strong advocate of professionalism and higher education standards in financial planning and has contributed to various committees and working groups of the FPA, AFA, SMSFA, FSC, FINSIA and ANZIIF. He has authored many research papers, is regularly quoted in the media and has presented to audiences around Australia and overseas on various issues impacting professional advisory, particularly technical services and strategy, advice professionalism and legislative change. Jenneke Mills is the Manager of the MLC Technical Services team. She supports financial advisers and other key stakeholders with the interpretation and practical application of legislation relating to superannuation, SMSFs, retirement planning, taxation, social security and aged care. Jenneke is also a regular presenter at Professional Development days, and client seminars, and has over 10 years’

experience in the financial planning industry, having also worked as a financial adviser. Jenneke has tertiary qualifications in Commerce, Financial Planning and Economics. Shirley Murphy, BA (Hons), LLB (Hons), has, for many years, taught undergraduate and postgraduate tertiary students in the areas of taxation and superannuation. Shirley is co-author of Wolters Kluwer’s Australian Master Superannuation Guide. She has also previously contributed to a number of other Wolters Kluwer publications including the Australian Master Tax Guide and Australian Superannuation Law & Practice. Andrew Simpson, BA, LLB, LLM (Comm law), is a Principal of Maurice Blackburn Lawyers and is the National Leader of its Wills and Estates Division. Anna Tabas, BComm/BArts, Graduate Diploma of Chartered Accounting and a Registered Tax Agent, is a Finance and Operations Manager and a member of the Management Team at Preacta Pty Ltd where she is responsible for the financial compliance and strategy of the company. Prior to this, she was a Financial Accountant at Social Enterprise, MTC Australia and a Tax Accountant at Crispin and Jeffery Accountants. Susan Warda is team leader of the Sydney family law practice at Mills Oakley. She has particular expertise in family law matters that involve complex financial issues, including property settlements that incorporate family businesses, multiple assets and superannuation splitting. Susan is an accredited specialist in family law and was named 2013 Woman Lawyer of the Year in Private Practice by the Women Lawyers Association of NSW. She has been endorsed as a Leading Family Lawyer (High-Value & Complex Property Matters) in Doyle’s Guide 2018 as well as a Recommended Sydney Family & Divorce Lawyer in Doyle’s Guide 2019. She has also been named as a Recommended Family Lawyer (Sydney) by Best Lawyers (2019 and 2020). Mary Zachariah, BBus, MTax is a content specialist, writing mainly for the Wolters Kluwer Australian Federal Tax Reporter and the Australian Master Tax Guide. She was previously a tax manager in a major accounting firm.

Checklist of Terms This quick checklist explains terms which are used throughout the Guide. ABN

Australian Business Number

AFCA

Australian Financial Complaints Authority

AML/CTF

Anti-money laundering and counter-terrorism financing

APRA

Australian Prudential Regulation Authority

ASIC

Australian Securities and Investments Commission

ATC

Australian Tax Cases (Wolters Kluwer), from 1969

ATI

Adjusted taxable income

ATO

Australian Taxation Office

AWOTE

Average weekly ordinary time earnings

CGT

Capital gains tax

CIPR

Comprehensive Income Products for Retirement

CPI

Consumer Price Index

ETP

Employment termination payment

FBT

Fringe benefits tax

FOFA

Future of Financial Advice

FPA

Financial Planning Association

FSG

Financial Services Guide

FSR

Financial Services Reform

GST

Goods and services tax

ITAA36

Income Tax Assessment Act 1936

ITAA97

Income Tax Assessment Act 1997

LIF

Life insurance framework

PAYG

Pay As You Go

PDS

Product Disclosure Statement

RoA

Record of Advice

SG

Superannuation guarantee

SIS

Superannuation Industry (Supervision)

SISA

Superannuation Industry (Supervision) Act 1993

SISR

Superannuation Industry (Supervision) Regulations 1994

SMSF

Self managed superannuation fund

SoA

Statement of Advice

TAA

Taxation Administration Act 1953

TAP

Term allocated pension

TBC

Transfer balance cap

TFN

Tax file number

What’s New in the 2020/21 Guide Chapter 1 Income tax • Content has been updated for changes in the rate for small business tax offset..................................... ¶1-055; ¶1-283 • The commentary has been updated for changes in the tax rate for base rate entities..................................... ¶1-055; ¶1-400 • Content has been updated for changes in the instant asset write-off for small businesses..................................... ¶1-283 • New content for instant asset write-off for businesses with aggregated turnover less than $500m has been included..................................... ¶1-330 • New content for accelerated depreciation for businesses with aggregated turnover less than $500m has been included..................................... ¶1-330 Chapter 2 Capital gains tax • Seismic data is not a CGT asset (Taxation Ruling TR 2019/4)..................................... ¶2-100 • Certain arrangements, referred to as “trust splits”, can cause CGT event E1 to occur (Taxation Determination TD 2019/14)..................................... ¶2-110 • The cost base of an asset for CGT purposes includes the cost of liabilities assumed in acquiring the

asset to the extent that a deduction for an amount of that liability is not otherwise claimed (Draft Taxation Determination TD 2019/D11)..................................... ¶2-200 • Penalty interest that is an incidental cost incurred in relation to a CGT event or to acquire a CGT asset is included in the cost base or reduced cost base (Taxation Ruling TR 2019/2)..................................... ¶2-200 • The government has proposed measures to prevent managed investment trusts (MITs) and attribution MITs (AMITs) from applying the 50% discount at the trust level..................................... ¶2-215 • The Court has provided guidelines on the meaning of “active asset” for the purposes of the small business CGT concessions (FC of T v Eichmann 2019 ATC ¶20-728; Fed Ct)..................................... ¶2-320 • The Commissioner states that the capital gains of a foreign resident beneficiary from a non-fixed resident trust are not disregarded under Subdiv 855-A; additional capital gains under Subdiv 115-C are also not disregarded (Draft Taxation Determination TD 2019/D6)..................................... ¶2-360 • The Commissioner’s view is that the concept of “source” is not relevant for determining the amount of a trust capital gain that is assessable to a non-resident beneficiary or trustee (Draft Taxation Determination TD 2019/D7)..................................... ¶2-360 • Where the 50% CGT discount is applied to a foreign capital gain, only 50% of the foreign tax paid on the gain is available for FITO purposes (Burton v FC of T 2019 ATC ¶20-709; Fed Ct)..................................... ¶2-520 • The Commissioner has warned about certain arrangements that purportedly allow a unit trust to effectively dispose of a CGT asset to an arm's length purchaser with no CGT consequence (Taxpayer Alert TA 2019/2)..................................... ¶2-650 • The Commissioner has warned about international arrangements that mischaracterise Australian activities connected with the development, enhancement, maintenance, protection and exploitation (DEMPE) of intangible assets (Taxpayer Alert TA 2020/1..................................... ¶2-650 Chapter 3 Fringe benefits tax • The ATO has released preliminary guidelines on the meaning of “commercial parking station” and the provision of a car parking fringe benefit in the FBTAA (Draft Taxation Ruling TR 2019/D5)..................................... ¶3-420 • The ATO has released TR 2020/1 which gives views on employee deductions for work expenses and provides both foundation guidance on general deductibility principles and direction to the more specific guidance products that are of most relevance to particular issues or expense types (Taxation Ruling TR 2020/1)..................................... ¶3-500 • New definitions of “taxi” and “taxi travel” apply from the 2019/20 FBT year for taxi travel fringe benefits purposes..................................... ¶3-600 Chapter 4 Superannuation • Employer contributions to the superannuation small business clearing house may be treated as made, and therefore deductible, in the year they are made to the clearing house if the conditions in ATO guideline Practical Compliance Guideline PCG 2020/6 are met..................................... ¶4-203 • Individuals who reached age 65 before 1 July 2020 or who reach age 67 on or after 1 July 2020 may be exempt from the work test..................................... ¶4-205 • Employer superannuation contributions resulting from a salary sacrifice arrangement do not count as SG contributions from 1 January 2020 and must be reported on the employee’s payment

summary..................................... ¶4-215 • A member’s share of the outstanding balance of a limited recourse borrowing arrangement may be included in their total superannuation balance if the borrowing arises under a contract entered into on or after 1 July 2018..................................... ¶4-233 • A Bill proposes that from 1 July 2020 individuals aged 65 and 66 whose non-concessional contributions exceed $100,000 may be eligible to access the bring forward arrangements..................................... ¶4-240 • A temporary condition of release is available to allow individuals adversely impacted by COVID-19 to apply to have up to $10,000 released from superannuation up to 30 June 2020 and an additional $10,000 up to 31 December 2020..................................... ¶4-400 • From 1 January 2020, an employee who receives income from multiple employers can apply to the Commissioner for an employer shortfall exemption certificate which would exempt one or more of the employers from making SG contributions for the employee..................................... ¶4-520 • An employer covered by an employer shortfall exemption certificate has a maximum contribution base of nil in relation to an employee for the quarter to which the certificate relates..................................... ¶4-540 • Employers are not liable to additional SG obligations from their participation in the JobKeeper scheme..................................... ¶4-540 • A superannuation guarantee amnesty that applied from 24 May 2018 to 7 September 2020 allowed employers to self-correct certain underpayments of SG amounts without incurring additional penalties that would normally apply..................................... ¶4-560 • Where an employee is employed under an enterprise agreement or workplace determination made on or after 1 July 2020, the employer is required to offer choice of fund to new employees..................................... ¶4-580 Chapter 5 Self managed superannuation funds • There has been an increase in the number of SMSFs over the year to March 2020..................................... ¶5-010 • The value of a penalty point has increased from $210 to $222..................................... ¶5-020 • Changes to non-arm’s length income and non-arm’s length expenses are discussed..................................... ¶5-040 • Sole purpose declaration for funds may be in breach of the decision in Aussiegolfa Pty Ltd (Trustee) v FC of T 2018 ATC ¶20-664..................................... ¶5-320 • Exemption from in-house asset test for limited recourse borrowing arrangements involving intermediary lending arrangements..................................... ¶5-360 • Inclusion of outstanding LRBA balances for related party and some third-party loans as a total superannuation balance credit for certain members of an SMSF..................................... ¶5-360 • The ATO has expressed concerns over land development and potential breaches of the SISA and potential non-arm’s length income implications..................................... ¶5-380 Chapter 6 Social security • The commencement of changes to the reporting of employment income has been delayed to 7 December 2020 due to COVID-19..................................... ¶6-050

• From 20 December 2019, clients aged 80 and over who receive a Centrelink pension overseas will need to complete a proof of life certificate every two years to continue receiving their payment..................................... ¶6-050 • Two separate $750 economic support payments were paid to people receiving eligible payments and concession cards..................................... ¶6-050 • Due to the financial impacts of COVID-19, the qualification criteria for JobSeeker Payment have been temporarily expanded..................................... ¶6-190 • A COVID-19 supplement of $550 pf is payable until 31 December 2020 to people receiving a number of income support payments including JobSeeker Payment..................................... ¶6-190 • Changes to parental leave pay commenced from 1 July 2020..................................... ¶6-350 Chapter 7 Life and personal risk insurance • Income protection insurance details have been updated for changes that mean agreed basis policies are no longer available..................................... ¶7-320 • Proposed changes to income protection to be introduced by APRA are discussed..................................... ¶7-345 • New disclosure requirements are proposed from 5 April 2021..................................... ¶7-450 • Commentary on the cancellation of automatic insurance for low-balance and inactive accounts has been updated..................................... ¶7-890 • Details of the Insurance in Superannuation Voluntary Code of Practice have been updated..................................... ¶7-998 Chapter 8 Compliance and best practice for financial advisers • Commentary has been updated to include relevant legislation and expanded to give more context on FSRA and to explain the impact of the FOFA reforms on financial advice..................................... ¶8010 • In February 2019, the Financial Adviser Standards and Ethics Authority (FASEA) introduced the most significant reforms to financial advice since FOFA with the release of the Financial Planners and Advisers Code of Ethics. In addition to the statutory and regulatory requirements that financial advisers and licensees are subject to, the Code has introduced a broad set of ethical obligations distilled into five overarching values and 12 ethical standards..................................... ¶8-020 • The term “safe harbour” has been considered in the context of s 961B(2) of the Corporations Act 2001, alongside a comparison of the legislated “best interest duty” under FOFA and in the FASEA Code of Ethics..................................... ¶8-120 • New commentary has been included on “achieving safe harbour” and what an adviser needs to do under the Corporations Act to show that they have met their best interest duty..................................... ¶8-120 • The figures for the maximum penalties for individuals and companies under the penalty regime have been updated..................................... ¶8-125 • Commentary on the ongoing fee arrangements and the interaction with the regulations has been updated..................................... ¶8-155 • Proposed legislation may remove the ability for FPA members to register and use the FPA Professional Ongoing Fees Code from 1 July 2020. Until there is clarity on whether the government

will keep or remove s 962CA of the Corporations Act, the FPA will not be taking new applications from members under the Code..................................... ¶8-155 • Content on the minimum requirements with regard to wholesale advice has been updated..................................... ¶8-240 • More detail has been added on the FASEA exam, further education, recognition of prior learning (RPL) and professional designations..................................... ¶8-265 • Commentary on tax-related advice has been updated..................................... ¶8-350 • New content has been added on complying with KYC requirements during the COVID-19 pandemic..................................... ¶8-370 • Commentary on strengthened penalties for breaches of corporate laws has been added..................................... ¶8-420 Chapter 9 Investment • This chapter has been updated with market results for period ending 31 December 2019. Chapter 10 Salary packaging • From 1 January 2020, employers are no longer allowed to use salary sacrifice superannuation contributions to meet superannuation guarantee obligations..................................... ¶10-040; ¶10-430 • Commentary on the living-away-from-home allowance has been rewritten to provide clarification of the current rules..................................... ¶10-350 • Commentary on the meal and entertainment benefits for FBT concessional employers has been rewritten to provide clarification of the current rules..................................... ¶10-620 • All case studies and examples have been updated for 2020/21 tax and FBT rates. Chapter 11 Gearing • Reserve Bank interest rates have been updated..................................... ¶11-420 • Residential property prices are expected to fall as a result of COVID-19..................................... ¶11550 Chapter 12 Family home • A shortcut method for claiming home office running expenses is available as a result of COVID19..................................... ¶12-066 • There have been changes to deferral of the Pensioner Duty Concession Scheme (PDCS) in the ACT..................................... ¶12-096 • As a result of COVID-19, the government is temporarily providing eligible owner-occupiers (including first home buyers) a grant of $25,000 to build a new home or substantially renovate an existing home..................................... ¶12-096 • Details of the new First Home Loan Deposit Scheme has been included..................................... ¶12097 • Content has been updated for the main residence exemption exclusion for foreign residents..................................... ¶12-645 Chapter 13 Financial planning for the family

• The approximate costs of education today have been included to reflect the most current estimations..................................... ¶13-205 • HECS repayment thresholds and repayment rates have been updated..................................... ¶13-410 • Changes to the paid parental leave scheme which increase the flexibility available to individual’s participating in the scheme have been explained..................................... ¶13-705 • The Child Care Subsidy income thresholds and subsidy percentages have been updated to reflect the 2020/21 financial year. Of note, the subsidy percentage has been significantly reduced for those earning income at certain levels. An updated case study demonstrates how entitlement to the subsidy is calculated..................................... ¶13-730 Chapter 14 Redundancy, early retirement and invalidity • All case studies and examples have been updated for the 2020/21 rates and thresholds. Chapter 15 Planning to retire • Reference to the FASEA Code of Ethics which increases the importance of retirement planning has been included..................................... ¶15-005 • Discussion on the various phases of retirement that will impact income requirements has been included..................................... ¶15-010 • There is a proposal to increase the age for triggering bring-forward rules for non-concessional contributions..................................... ¶15-048 • Updates have been made for the impact of changes to the work test rules when contributing to superannuation..................................... ¶15-050 • Updates have been made for the impact of changes to ages for the work test rules when making spouse contributions..................................... ¶15-190 • Details of the COVID-19 early release of superannuation measures have been added..................................... ¶15-400 • All case studies and examples have been updated for 2020/21 rates and thresholds. Chapter 16 Retirement income streams • ASFA retirement standard income figures have been updated..................................... ¶16-115 • Reference has been made to the Retirement Income Stream Review..................................... ¶16-137 • The minimum income payments have been halved due to COVID-19..................................... ¶16-190; ¶16-410; ¶16-585 • The social security assessment of income streams section has been re-written and grouped together for easier reference and to aid comparison of income stream types..................................... ¶16-590 – ¶16-598 • All case studies and examples have been updated for 2020/21 rates and thresholds. Chapter 17 Retirement living and aged care • New tip added: a downsizer superannuation contribution may provide an opportunity to execute a recontribution strategy, even where the sale proceeds are earmarked for other purposes..................................... ¶17-025

• Content on the types of services available to participants of the Commonwealth Home Support Programme has been added..................................... ¶17-110 • There are some things to be considered in assessing whether there is any benefit to completing an assessment in the case of a resident who would hit the annual means tested fee cap based on their income and assets..................................... ¶17-340 • All case studies have been updated to reflect the new rates and thresholds that apply from 1 July 2020. Chapter 18 Financial and estate planning on family breakdown • Commentary regarding the treatment of increases in the value of real property in the assessment of contributions has been updated with reference to the decision in Jabour & Jabour 2019 FLC ¶93898..................................... ¶18-105 • Commentary has been updated to include relief under s 90AE and the Court’s ability to bind the Commissioner of Taxation to substitute one spouse for the other in relation to a debt owed to the Commonwealth with reference to the decision in Commissioner of Taxation and Tomaras & Ors (2018) FLC ¶93-874..................................... ¶18-105 • Commentary in relation to the treatment of inheritances received post-separation in the assessment of contributions has been expanded..................................... ¶18-105 • Commentary has been updated to include consideration of changes to superannuation tax breaks and the effect on property settlement negotiations..................................... ¶18-400 • The ATO’s Ruling in relation to commercial debt forgiven for reasons of natural love and affection has been included..................................... ¶18-510 • The maximum combined adjusted child support income has been updated for the 2020/21 income year..................................... ¶18-705 Chapter 19 Estate planning and the consequences of death • The special disability trust assets value limit for 2020/21 is $694,000..................................... ¶19-300 • The payment of a child pension from superannuation is subject to modified transfer balance cap rules, which limit the amount of the superannuation death benefits that can be taken as an income stream by a minor child..................................... ¶19-405 Chapter 20 Rates and tables • Where available, all taxation, superannuation and social security rates and thresholds have been updated for 2020/21. Chapter 21 Online investing • Website references have been updated through the chapter.

INTRODUCTION TO FINANCIAL PLANNING NAVIGATOR About CCH

¶1

Introduction

¶2

Contents

¶4

¶1 About Wolters Kluwer CCH Wolters Kluwer CCH is part of a leading global organisation publishing in many countries. CCH publications cover a wide variety of topical areas, including tax, accounting, finance, superannuation, company law, contract law, conveyancing, torts, occupational health and safety, human resources and training. In the areas of taxation, superannuation and financial planning, CCH publishes a comprehensive range of online subscription products, loose-leaf services, annual books and newsletters. Titles relevant to this product include Australian Master Financial Planning Guide, Australian Master Tax Guide, Australian Master Superannuation Guide, Australian Income Tax Guide, Australian Superannuation Law & Practice and Superannuation Digest.

¶2 Introduction The Financial Planning Navigator is the complete financial planning reference manual for all financial planning professionals. Based on material from the respected CCH Master Financial Planning Guide, it contains practical and useful material to meet your information needs. To keep you to date with all the latest developments affecting financial planning, the Financial Planning Navigator is comprehensively updated on a regular basis. To access the latest information, click on the “What’s New” tab on your left-hand navigation panel.

¶4 About the authors Michael Beer, Masters of Financial Planning, Diploma of Financial Advising and Certified Investment Management Analyst (CIMA). Michael has over 17 years’ industry experience and currently holds a Senior Manager role in one of Australia’s leading Financial Institutions. Prior to this role, Michael was the Research and Platforms Manager and he has previously held roles as a Financial Planner and a ParaPlanner. Louise Biti, CFP®, SSA, CTA, MTax, BEc, BA(AS), DipFP is a Director of Strategy Steps and Aged Care Steps, providing support to advice professionals in relation to legislative issues and financial planning strategies. She has broad experience across taxation, superannuation, aged care, estate planning and social security legislation. Louise is a previous Director of the Financial Planning Association and SMSF Association boards and has been awarded the FPA’s Distinguished Service award. She is a regular speaker at industry conferences and is often quoted in the media. Jennifer Brookhouse, BComm, Diploma of Financial Planning, is Senior Technical Consultant with NAB at MLC Technical Services. Prior to this role, she was Head of Technical Services for Zurich Financial Services and National Technical Manager at ING. In both these roles, she was responsible for the analysis and interpretation of technical issues relating to superannuation, social security and taxation legislation. Michael Chow, BA, LLB, is the editor of the CCH Australian Master Tax Guide and is also a contributing writer. In addition, he writes for a number of other CCH tax publications. Previously, Michael worked in

various technical areas of the ATO. Gaibrielle Cleary, BEc, LLB, LLM (U Syd), is the Director of Taxation at Duncan Dovico. Gaibrielle practises in all areas of direct and indirect taxation. Previously, she has been the in-house counsel for an ASX listed company and practised at leading international law and accounting firms. She is one of the authors of CCH’s Small Business Tax Concessions Guide, and has also written for a number of taxation publications, including CCH’s Federal Tax Reporter. Graeme Colley, CA SSA teaches as an adjunct lecturer at the UNSW and WSU in taxation, superannuation and self managed superannuation funds to post-graduate students. He has also held positions with the SMSF Association as Head of Technical and Professional Standards, National Technical Manager with ING and considerable experience in the ATO with superannuation. Adam El-Ansary has 10 years industry experience and currently holds an Equities Product Manager role in one of Australia’s leading financial institutions. His previous experience includes eight years working for one of Australia’s largest online stockbrokers, working in a variety of roles including Service Manager, Business Analyst, and Commercial & Contracts Manager. Kim Guest is a Senior Technical Manager at FirstTech. Kim joined FirstTech, the Colonial First State technical team in May 2012. Prior to joining FirstTech, Kim was the Technical Services Manager at Count Financial. Kim has over 16 years’ experience in the financial planning industry, holding several roles including Technical Analyst, Business Analyst and Paraplanner. Kim also has significant experience with Centrelink and aged care having worked as a Financial Information Service Officer and Policy Officer in the Financial Industry Network Support Unit of Centrelink. Kim provides technical information and strategy advice on a range of areas specialising in social security, aged care and superannuation. Kim holds a Bachelor of Economics and a Diploma of Financial Planning. Graham Horrocks, BSc (ANU), FIAA, is an actuary specialising in financial planning and superannuation. He was a consultant with a leading superannuation and actuarial firm from 1984 and assisted their financial planning operation from its inception in 1988. He took up the position of General Manager, Research & Quality Assurance when Ord Minnett Investment Planning was established in 1995. Graham has been self-employed since April 1999. James Leow, LLB (Hons), MTax (UNSW), is a tax and superannuation writer. He is co-author of the CCH Master Superannuation Guide and editor of the CCH Superannuation Law and Practice, and writes for a number of other CCH publications. Heino Ling, FCPA, CPA (FPS), MBA, CFS, AFP®, AFA, QPIA®, BA, F Fin, AdvDipFS (FP), Dip Finance & Mortgage Broking, LREA & Auctioneer, Registered Tax Agent, AFAIM, MFAA Credit Adviser™, JP, has a great depth of experience and knowledge from over 40 years’ experience in the financial services industry. He has held executive positions in life offices, banks, consulting companies, superannuation and financial planning organisations and has held a personal Australian Financial Services and a Australian Credit Licence. He is a member of the course advisory committee for NSW TAFE’s Bachelor of Finance (Financial Planning) degree and is currently Executive Manager, Assessment Technical Support in the Wealth Management Division of the Commonwealth Bank. Shirley Murphy, BA (Hons), LLB (Hons), has, for many years, taught undergraduate and postgraduate tertiary students in the areas of taxation and superannuation. Shirley is co-author of CCH’s Australian Master Superannuation Guide. She has also contributed to a number of other CCH publications including the Australian Master Tax Guide and Australian Superannuation Law & Practice. Andrew Simpson, BA, LLB, LLM (Comm law), is a Principal of Maurice Blackburn Lawyers and is the National Leader of its Will Disputes Division. Nabil Wahhab, BEc LLB (Hons), is a Director of York Law Family Law Specialists, a specialist boutique family law firm in Sydney. He is an Accredited Family Law Specialist and a trained mediator. Nabil’s main practice is to advise and represent clients on complex family financial and tax issues in property settlements. He regularly publishes on financial and estate planning issues and presents on family law issues to lawyers, accountants and financial advisers on taxation, financial and estate planning issues in family law. He also regularly represents third parties in family law financial settlements. He is also on the panel of solicitors that represent children in family law parenting matters.

Erika Wilke, CFP®, BA, Graduate Dip in Sociology, Dip Financial Planning, is a Director of an independent licensed financial planning practice, PrimeCare Financial Planning Pty Ltd., which specialises in a range of aged care services including aged care financials, placement, RAD negotiations and Centrelink/DVA service. Erika leads her team to hold regular training and educational sessions on “Understanding the Age Care Maze” and chairs aged care forums. She is a Board Director of Peninsula Health, a large public hospital network in Victoria and a board member for a not for profit aged care facility. Erika is also a member of an Aged Care & Health Forum. Tina Doan LLB, BComm (UNSW), Dip Financial Planning, is the CCH financial planning editor. She has previously worked as a paraplanner with AXA Financial Planning and Zurich Financial Services. She has also previously worked as a solicitor and tax consultant.

INCOME TAX The big picture

¶1-000

Calculation of income tax and Medicare levy, including taxation of minors Taxable income

¶1-050

Tax payable

¶1-055

Self-assessment

¶1-060

Tax losses

¶1-065

Taxation of minors

¶1-070

Medicare levy and surcharge

¶1-075

Interaction between income tax and FBT

¶1-090

Payment of income tax and collection systems Financial year and income year

¶1-100

Collection of tax

¶1-105

Failure to quote TFN to investment body

¶1-115

Australian Business Number

¶1-120

Withholding tax on dividends, interest and royalties Dividend, interest and royalty withholding tax

¶1-150

Assessable income and exempt income Annual basis of taxation

¶1-250

Assessable income

¶1-255

Exempt income

¶1-260

Income from personal services and pensions

¶1-265

Income from investments

¶1-270

Transactions in property and securities, other financial dealings and life assurance ¶1-275 Partnership and trust income

¶1-280

Small business entities

¶1-283

Employment termination payments (ETPs) and superannuation lump sums

¶1-285

Superannuation income streams

¶1-290

Capital gains tax

¶1-295

Deductions Annual basis of taxation

¶1-300

General and specific deductions

¶1-305

Business deductions

¶1-310

Employment and self-employment deductions

¶1-320

Deductions for investors and landlords

¶1-325

Depreciating assets

¶1-330

Capital works expenditure

¶1-335

Other capital allowances

¶1-340

Deductible gifts and donations

¶1-345

Tax offsets What are tax offsets?

¶1-350

Concessional rebates and offsets

¶1-355

Companies Method of taxing company income

¶1-400

Imputation system

¶1-405

Partnerships Wide definition of partnership for tax purposes

¶1-450

Method of taxing partnership net income or loss

¶1-455

Exceptions: direct application of law to partners

¶1-460

Assignment of partner’s interest in partnership

¶1-465

Trusts What is a trust?

¶1-500

Method of taxing trust income or loss

¶1-505

When is a beneficiary presently entitled?

¶1-510

Beneficiary under a legal disability

¶1-515

No beneficiary presently entitled to income of deceased estate

¶1-520

Restrictions on deductions for trust losses

¶1-525

Tax consequences of a trust vesting

¶1-530

Cross-border issues Resident vs non-resident

¶1-550

Source of income

¶1-555

Thin capitalisation

¶1-560

Australians investing overseas

¶1-565

Accruals taxation system

¶1-570

Foreign income tax offset

¶1-575

Foreign losses

¶1-580

Tax avoidance How the law deals with tax avoidance

¶1-600

Specific anti-avoidance provisions

¶1-605

Distribution washing provisions

¶1-607

General anti-avoidance provisions: Pt IVA

¶1-610

Transfer pricing

¶1-615

Rulings Role of rulings

¶1-650

Rulings binding on Commissioner

¶1-660

Objection and review of rulings

¶1-665

Returns, assessments and review Tax returns

¶1-700

Tax assessments

¶1-705

Review of assessments and other decisions

¶1-710

Penalties Scheme of income tax penalties

¶1-750

Administrative penalties

¶1-755

Offences against the taxation laws

¶1-760

¶1-000 Income tax

The big picture This chapter provides an introduction to key concepts of Australia’s income tax system. It should assist with understanding the more detailed discussion of specific areas of the income tax law in other chapters. Calculation of tax .................................... ¶1-050 • Income tax is payable for each financial year by individuals and companies and by some other entities, such as corporate limited partnerships, superannuation funds and trustees of trusts (in respect of certain trust income). The income of partnerships and trusts is generally taxed in the hands of the partners and beneficiaries. Individuals who are Australian residents, and some trustees, are also liable to pay the Medicare levy each year. • Under Australia’s self-assessment system, assessments of taxable income and tax payable are initially based on the information shown in the taxpayer’s income tax return, with the Australian Taxation Office (ATO) having wide powers to amend assessments in the light of subsequent audits. Taxable income is calculated by subtracting deductions from assessable income. A tax loss arises if deductions exceed the assessable income and any net exempt income. The tax loss may be a deduction in a later year. • Assessable income consists of income according to ordinary concepts (eg salary or wages) and statutory income, being amounts that are made assessable income by specific provisions of the law, such as the capital gains tax (CGT) provisions. Exempt income and non-assessable non-exempt income are not included in assessable income (eg income that is a fringe benefit). • Deductions include losses or outgoings incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for that purpose. Losses or outgoings of a capital, private or domestic nature are not deductible. Deductions are also allowed under specific provisions of the law, such as the depreciation and gift provisions. • Tax payable is the amount remaining after subtracting tax offsets from gross tax. The gross tax of an individual is calculated by applying progressively greater marginal rates to successive slices of taxable income, the bottom slice for residents being tax-free. The gross tax of a company is calculated by applying a single rate to the whole of the taxable income. Examples of tax offsets are the concessional rebates and foreign tax credits. Excess tax offsets (apart from imputation credits)

are generally not refundable and cannot be offset against later years’ tax. Collection of tax .................................... ¶1-105 • Income tax is usually collected in instalments before a person’s actual tax liability for the year can be calculated. Amounts are paid, usually at regular intervals, under the Pay As You Go (PAYG) system as income is earned during the year, and these amounts are credited in payment of the tax assessed. PAYG withholding applies to salary and wage earners and the PAYG instalments system applies to taxpayers, including companies, with business and/or investment income that is not subject to PAYG withholding. Individuals who have an Australian Business Number (ABN) can enter into a voluntary agreement with a payer to have PAYG withholding apply to payments for the performance of work or services. • Non-residents who derive dividends (other than most franked dividends), interest or royalties from Australia generally pay the tax on that income as a flat rate final withholding tax, collected by the payer under the PAYG withholding system. Non-final CGT withholding applies to the disposal of certain taxable assets by a non-resident. Companies .................................... ¶1-400 • Companies are taxed as separate legal entities. The tax paid by Australian resident companies is then imputed, or credited, to resident individual shareholders when they are assessed on franked dividends. Franked dividends paid to non-residents are not included in assessable income and are generally exempt from withholding tax. • Companies are not entitled to a deduction for prior years’ losses unless the company satisfies either a continuity of ownership or business continuity test. Wholly owned groups of companies, trusts and partnerships can choose to be taxed as a single consolidated entity. Partnerships and trusts .................................... ¶1-450, ¶1-500 • Partnership and trust income is taxed to the partners and to the trust beneficiaries who are presently entitled to the income, which retains its character in their hands (eg franked dividends). Trustees may be taxed on some trust income (eg income to which no beneficiary is presently entitled). Some provisions of the law (eg the CGT provisions) apply directly to partners and not to the partnership. Partnership losses are allocated to the partners but trust losses are carried forward in the trust as deductions from future trust income, subject to conditions. Limited partnerships and some public unit trusts are taxed as companies. Cross-border issues .................................... ¶1-550 • A person’s country of residence and the source of income are fundamental determinants of liability for Australian income tax. Australian residents are taxed on income from all sources, while nonresidents are taxed only on income from Australian sources. Agreements between Australia and other countries for the avoidance of double taxation override domestic law and allocate taxing rights on certain income to Australia or the other country. An agreement may, for example, include rules for determining whether a person is a resident of Australia or the other country. • An Australian resident with foreign investments is taxed on investment income actually derived, and can also be taxed on an accruals basis on certain income derived by non-resident entities or accumulated through certain offshore investments. A credit for foreign tax paid is allowed against Australian tax on foreign income. Foreign losses may be deducted against both Australian-sourced and foreign-sourced income. Tax avoidance .................................... ¶1-600 • Specific anti-avoidance provisions deal with particular tax avoidance practices and a general antiavoidance provision can apply to arrangements as a last resort after the application of all other provisions of the law have been considered. A determination can be made under the general provision to cancel a tax benefit of a kind to which the provision applies. Specific measures deal with distribution washing arrangements. Another anti-avoidance provision deals with transfer pricing arrangements to shift profits out of Australia. Other processes, obligations, rights and penalties .................................... ¶1-650

• Taxpayers are obliged to keep records, provide information and lodge returns. Failure to meet obligations under the income tax law may give rise to penalties. The Commissioner makes private, public and oral rulings, binding on the Commissioner, on the way in which, in the Commissioner’s opinion, particular provisions of the law apply. Taxpayers can apply to the Administrative Appeals Tribunal (AAT) for a review of certain decisions of the Commissioner, or appeal to the Federal Court.

CALCULATION OF INCOME TAX AND MEDICARE LEVY, INCLUDING TAXATION OF MINORS ¶1-050 Taxable income Income tax is worked out by reference to the taxable income of a taxpayer for an income year. The formula for working out the taxable income of an individual or a company (¶1-400) is:

Taxable income = assessable income (¶1-250) − deductions (¶1-300)

Partnerships (¶1-450) and trusts (¶1-500) generally are not treated as taxpayers and do not have a taxable income. There are, however, exceptions to the general rule. A partnership is taxed as a company if the liability of any partner is limited. Some public unit trusts are also taxed as companies. Trustees of superannuation funds, approved deposit funds (ADFs) and pooled superannuation trusts (PSTs) are liable to pay tax on the taxable income of the fund or trust.

¶1-055 Tax payable The formula for working out tax payable on taxable income is:

Tax payable on taxable income = gross tax − tax offsets (¶1-350)

Examples of tax offsets are the low income tax offset (“LITO”), the private health insurance offset, the franking credit offset, the foreign income tax offset and the tax offset for investments in early stage innovation companies. If total tax offsets exceed the gross tax, no tax is payable but the taxpayer is generally not entitled to a refund of the excess. However, some taxpayers, primarily individuals and superannuation funds, who receive franking credits are entitled to a refund if their franking credits exceed tax payable. The private health insurance offset is also a refundable offset. Gross tax of individuals The gross tax of an individual for 2020/21 is calculated according to the following scale of rates (excluding Medicare levy*): Slice of taxable income ($)

Marginal rate of tax (%) Resident

Non-resident

 1–18,200

Nil

32.5

18,201–37,000

19

32.5

37,001–90,000

32.5

32.5

90,001–180,000

37

37

180,001+

45

45

* Non-residents are not liable for the Medicare levy.

For 2020/21, residents are entitled to a LITO of $445 for taxable income less than $37,000. The rebate reduces by 1.5 cents for every dollar by which the taxable income exceeds $37,000 with no rebate applying on taxable incomes of $66,667 or more. The rebate is not available for “unearned” income of minors (¶1-070). In addition, a low and middle income tax offset (“LMITO”) is available to individuals with relevant taxable income that does not exceed $126,000. The amount of the LMITO is: • for taxpayers with income not exceeding $37,000 — $255 • for taxpayers with income exceeding $37,000 but not exceeding $48,000 — $255 plus 7.5% of the amount of the income that exceeds $37,000 • for taxpayers with income exceeding $48,000 but not exceeding $90,000 — $1,080, and • for taxpayers with income exceeding $90,000 — $1,080 less 3% of the amount of the income that exceeds $90,000. The effect of the existing LITO and LMITO means no income tax (excluding Medicare levy) is payable in 2020/21 until the resident’s taxable income exceeds $21,884. Example Carol is a teacher whose salary for the year ended 30 June 2021 is $61,000. Carol earned interest income of $200. During the year she incurred $800 of work-related expenses (union fees, reference books and depreciation on library), made tax-deductible gifts totalling $300 and paid $100 to have her tax return prepared. Carol’s tax liability for 2020/21 is calculated as follows:

$  Salary

61,000

Interest

 200

ASSESSABLE INCOME

$61,200

Less: $ Work-related expenses

800

Gifts

300

Tax return preparation

100

TAXABLE INCOME Gross tax payable (excluding Medicare) at 2020/21 rates on a taxable income of $60,000 (see the table at ¶20-010)

1,200 $60,000 11,047

Less: LITO ($445 − ([60,000 − 37,000] × 1.5%)) LMITO:

100 1,080

Ordinary tax payable

9,867

Plus: Medicare levy (2% × $60,000)

TAX PAYABLE (including Medicare levy)

 1,200

$11,067

Individuals deriving income from an unincorporated small business are entitled to the “small business tax offset” which effectively provides a discount of 13% on the income tax payable on that business income subject to a maximum cap of $1,000 per year (see ¶1-283). For more information about the calculation of income tax, see ¶20-010 to ¶20-030. Special rules modify the calculation of gross tax on certain income. Examples are unearned income of minors (¶1-070) and the taxable income of primary producers. Gross tax of companies The gross tax of a company is calculated by applying a single rate to the whole of the company’s taxable income. The applicable company tax rate will depend upon the classification of the company. The general company tax rate is 30%. However, where a company is a base rate entity a lower tax rate of 26% for 2020/21 applies (see ¶1-400). For more information about tax rates for companies and life assurance companies, see ¶20-070.

¶1-060 Self-assessment The Commissioner makes an assessment of an individual’s taxable income and tax payable on the basis of the information contained in the person’s income tax return (¶1-700) without examining the return in detail. This process is known as “self-assessment”. The Commissioner issues a notice of assessment (¶1-705) to an individual taxpayer requiring payment of any balance of tax payable but not collected under the Pay As You Go (PAYG) system (¶1-105) or refunding any excess amount collected. In the case of a company, the Commissioner is deemed to have made an assessment of the taxable income and tax payable specified in the tax return. The tax return is deemed to be a notice of assessment. This process is known as “full self-assessment”.

¶1-065 Tax losses If the deductions of a company, trust or individual exceed the assessable income and any net exempt income (¶1-260) for an income year, the resulting tax loss can be a deduction in calculating taxable income (net income in the case of a trust) in later years. There is no ability to carry back losses. A partnership can also make a loss for an income year, but the loss is allocated to the partners rather than being carried forward in the partnership. The tax treatment of losses of companies, partnerships and trusts is discussed at ¶1-400, ¶1-455 and ¶1-525 respectively.

¶1-070 Taxation of minors A person who is under 18 years of age at the end of the income year (a minor) is effectively taxed on unearned income, whether derived directly or through a trust, is taxed at the marginal rate of 45% for 2020/21 unless the minor was engaged in a full-time occupation at the end of the year or for at least three months during the year. Income derived by a minor from property received from a deceased estate is excluded. Certain disabled children and double orphans are also exempt from the rules. If the unearned income is $416 or less, the tax payable is nil. The LITO and the LMITO is not available for minors to offset unearned income (though it can offset income from ordinary employment). For more details of the tax calculation for minors, see ¶20-040.

Unearned income The types of income that constitute unearned income are not spelled out in the law. Unearned income is assessable income other than: • employment income • reasonable business income (having regard to the minor’s participation in the business) • income from a deceased estate or the investment of a range of property, including inherited property, property transferred to the minor as a result of a family breakdown, death benefits from life assurance or superannuation and certain compensation payments. A family breakdown occurs when a marriage or de facto relationship (including same sex) breaks down or where a child support order is made for the benefit of a child whose parents were not living together as spouses when the child was born. The taxation of minors in relation to family breakdown is covered in Chapter 18. Unearned income therefore includes income, such as dividends, interest and rents, from the investment of property acquired by the minor in ways other than those mentioned. As beneficiary of a trust If a minor is a beneficiary of a trust, the portion of the minor’s share of the net income of the trust that is attributable to unearned income is also subject to these rules. The income is taxed to the trustee at the rates that would have applied if the minor had derived the income. Business income of a trust is unearned income, as is employment income unless the minor does the work. A deceased estate’s income is not unearned income.

¶1-075 Medicare levy and surcharge A Medicare levy is payable by an individual who is a resident at any time during an income year. The levy is a fixed percentage of taxable income. The rate for 2020/21 is 2%. Low income individuals may pay no levy or a reduced one (¶20-020). A Medicare levy surcharge is imposed on high income taxpayers who do not have adequate private patient hospital insurance. These taxpayers are required to pay a levy surcharge on the whole of their taxable income, reportable fringe benefits and the net amount on which the family trust distribution tax has been paid. The Medicare levy surcharge applies on a tiered system. The relevant tiers for 2020/21 are as follows: Tier

Single Income Threshold

Families Income Threshold

Rate of Levy Surcharge

Nil

Up to $90,000

Up to $180,000

Nil

1

$90,001–$105,000

$180,001–$210,000

1%

2

$105,001–$140,000

$210,001–$280,000

1.25%

3

$140,001 and over

$280,001 and over

1.5%

“Families” includes couples and single parent families. The relevant families income thresholds increase by $1,500 for each independent child after the first. The freezing of these thresholds is due to be removed from 2021/22. The income for surcharge purposes is the total of the following amounts: • taxable income for the income year • reportable fringe benefits total • reportable superannuation contributions, and

• total net investment loss. Example For 2020/21, Neil has taxable income of $135,000, reportable superannuation contributions of $10,000 and no reportable fringe benefits or investment loss. Neil is married to Nancy who has taxable income of $80,000 and no reportable fringe benefits, reportable superannuation contributions or investment loss. Neither of them has adequate private patient hospital cover, nor do they have dependent children or receive trust distributions. They will both have to pay the additional 1.25% levy surcharge on their taxable income because their combined income for surcharge purposes is $225,000, being over $210,000 but below $280,000, even though Nancy earned less than $90,000. Consider if instead, Neil had taxable income of $135,000 and reportable superannuation contributions of $10,000 but Nancy’s taxable income was only $42,000. As their combined income is $177,000, being under the $180,000 threshold, neither of them would be required to pay the levy surcharge, notwithstanding that Neil’s income for surcharge purposes exceeds the single threshold of $90,000.

A trustee is generally liable to pay the Medicare levy in respect of a share of the net income of a trust (¶1505) to which a resident beneficiary, under a legal disability, is presently entitled, or to which no beneficiary is presently entitled. In the latter case special shade-in rules may apply. For more information about the calculation of the Medicare levy and Medicare levy surcharge, see ¶20020.

¶1-090 Interaction between income tax and FBT Income tax is not payable by employees on certain benefits which are dealt with under fringe benefits tax (FBT), such as car benefits and loan benefits. The value of such a benefit does not have to be included in the employee’s assessable income. FBT contains rules for working out the taxable values of benefits but FBT does not apply to certain specified benefits, such as salary or wages and contributions by employers to complying superannuation funds. For more details on the operation of FBT, see ¶3-000 and following. Reporting of benefits provided The value of certain fringe benefits is taken into account for the purpose of applying certain income tests, eg in determining liability to the Medicare levy surcharge, Higher Education Loan Programme (HELP) and Higher Education Contribution Scheme (HECS) debt repayments, the entitlement to concessions for personal and spouse superannuation contributions and the imposition of Div 293 tax on concessional superannuation contributions. For this purpose, employers are required to record through single touch payroll (STP) or on payment summaries the grossed-up taxable value of the benefits provided to the employee during the FBT year where the value of the benefits exceeds $2,000. Some fringe benefits do not have to be reported, including car parking fringe benefits, remote area benefits and meal entertainment fringe benefits. Salary sacrifice An employee’s after-tax position may be improved by replacing salary with certain benefits that are subject to concessional FBT treatment or are specifically exempt from FBT. Improvement will be evident where the FBT taxable value is such that the employer can meet the costs of both the benefit and the FBT out of the forgone salary and the employee’s benefit is greater than could have been acquired with the after-tax salary. A common example is a car benefit. Unless the benefit provided is concessionally taxed (for example, superannuation, a laptop, portable electronic equipment or a car benefit), there is generally little advantage to salary sacrificing benefits unless the employee is on the top marginal tax rate or works for a non-profit organisation. Further, care needs to be taken in salary sacrificing certain benefits as the usual concessional treatment for such benefits may be lost (eg in-house benefits). For more detailed information, see ¶10-010.

PAYMENT OF INCOME TAX AND COLLECTION SYSTEMS ¶1-100 Financial year and income year

Income tax is payable for a financial year but is calculated by reference to taxable income for an income year. The income year of an individual is also the financial year for which tax is payable. In contrast, a company’s income year is the year before the financial year for which tax is payable. Most taxpayers (including companies) are required to pay most of their tax during the income year through the PAYG instalment system (¶1-105).

¶1-105 Collection of tax Taxpayers are required to pay all or most of their annual tax liability before the actual tax payable on their taxable income can be worked out on assessment. Amounts are paid at regular intervals as income is earned during the year, and these amounts are credited in payment of the tax assessed. The system for collecting these advance payments of tax is called Pay As You Go (PAYG) and has two components: • PAYG withholding • PAYG instalments. PAYG withholding Payments subject to PAYG withholding are called “withholding payments”. The entity making the withholding payment is obliged to withhold an amount from the payment and pay the amount withheld to the Commissioner. The amount required to be withheld is worked out under withholding schedules that are available from the Australian Taxation Office (ATO). Withholding payments include the following: • payments of salary or wages, directors’ fees, superannuation pensions, annuities, taxable social security pensions and benefits, payments on retirement in lieu of unused annual leave or long service leave and ETPs (¶1-285) • payments for a supply (including supplies of goods, services and advice) where the payee does not quote its Australian Business Number (ABN) (¶1-120) • payments arising from an investment where the payee does not quote its tax file number (TFN) or ABN to the investment body (¶1-115) • dividends, interest or royalties paid to non-residents. The amount withheld is not to exceed the withholding tax (if any) payable in respect of the relevant dividend, interest or royalty (¶1-150) • a payment covered by a voluntary agreement between the payer and payee under an arrangement for the performance of work or services, where the payee is an individual and has an ABN. Agreements do not have to be lodged with the Commissioner, but must be in the approved form and must quote the payee’s ABN. A copy of the agreement must be kept by both parties for five years after the last payment covered by the agreement. Either party may terminate the agreement, in writing, at any time • the disposal of taxable Australian property (including indirect interests and options or rights to acquire such property) by a foreign resident is subject to limited exclusions (¶1-295). Variation of PAYG withholding amounts The Commissioner of Taxation has discretion to vary prescribed PAYG withholding rates if total amounts withheld for the income year are likely to significantly exceed the tax payable. Application forms are available from the ATO. Reasons for applying for a variation of withholding amounts could include: • an expected loss on another income-earning activity such as a negatively geared investment • expected significant work-related expenses • the receipt of an allowance from an employer for a tax-deductible purpose, eg travel • prior year losses

• known or expected entitlement to offsets on franked dividends to offset tax payable on salary or wages. The Commissioner will not approve a variation if any of the taxpayer’s tax returns are outstanding. The Commissioner cannot vary a withholding amount in relation to an investment where the investor does not quote a TFN or ABN. Other special cases PAYG withholding amounts may be lower in a range of circumstances: • The amount withheld can be reduced if a superannuation pension or annuity qualifies for a rebate or has a tax free component. • The rates of withholding from payments in respect of accrued leave on termination of employment generally match the rates of tax, some of which are concessional, that apply to such payments. Those rates of tax are set out at ¶1-265. • Where the disposal of the taxable Australian property by a foreign resident taxpayer would give rise to a tax loss and the taxpayer obtains a variation of the withholding. Employers may also be required by the Department of Human Services to make deductions of child maintenance from an employee’s salary or wages. PAYG instalments The PAYG instalment system applies to taxpayers who have business and/or investment income that is not subject to PAYG withholding. The system applies to individuals, companies and superannuation funds, corporate unit trusts, public trading trusts and, generally, to trustees who are assessable on trust income. PAYG instalments are payable only if the Commissioner gives the taxpayer an “instalment rate”. The instalment rate is, broadly, the taxpayer’s notional tax (ie a modified tax on taxable income) for the latest year for which an assessment has been made, expressed as a percentage of the taxpayer’s “instalment income” for that year. Individual taxpayers are liable for instalments where they have gross business or investment income of $4,000 or more ($1 or more for non-residents) in their most recent tax return unless one of the following applies: • the adjusted balance of the taxpayer’s last assessment was less than $1,000 • the taxpayer’s notional tax was less than $500 • the taxpayer is entitled to the seniors and pensioners tax offset. Companies, superannuation funds and self-managed superannuation funds (SMSFs), including those registered for GST, are not required to pay PAYG instalments if their notional tax is less than $500, even if their instalment rate is greater than 0%, unless: • their business and/or investment income (excluding capital gains) in their most recent income tax return is $2m or more, or • the taxpayer is the head of a consolidated group. Instalment income for a period (eg an income year or a quarter of an income year) is the taxpayer’s ordinary assessable income (eg business income) derived during the period, excluding amounts that are subject to PAYG withholding. Deductions for expenditure in the period are not taken into account. Nor, generally, is statutory income, such as capital gains and imputation credits. Complying and noncomplying superannuation funds, ADFs and PSTs have to include statutory income in their instalment. Partnerships do not have to pay PAYG instalments, but they need to calculate instalment income so that the partners can include their share in their individual instalment incomes. Quarterly instalments

The general rule is that taxpayers are required to pay their PAYG instalments quarterly unless the taxpayer has base instalment income of $20m or more and monthly instalments are required (see below). For taxpayers who pay their GST monthly, the due dates for PAYG instalments are 21 October, 21 January, 21 April and 21 July. For other taxpayers, the due dates are 28 October, 28 February, 28 April and 28 July. Quarterly instalments are not payable if the taxpayer is eligible to pay a single annual instalment and chooses to do so (see below). Certain primary producers, sportspersons, authors and artists are required to pay only two PAYG instalments, for the third and fourth quarters. The amount of a quarterly instalment for an individual, or for a company or superannuation fund whose previous year’s instalment income is $2m or less, is calculated by the Commissioner on the basis of the taxpayer’s latest assessed tax, with an adjustment for movements in Gross Domestic Product (GDP), and notified to the taxpayer. Alternatively, the instalment may be based on the taxpayer’s estimate of the current year’s tax liability net of PAYG withholding credits. These rules also apply to a company or fund whose previous year’s instalment income is over $2m if it is eligible to pay a single annual instalment but does not choose to do so. A taxpayer not eligible to pay its quarterly instalments on the above basis, or one that is eligible but chooses not to pay on the above basis, must calculate its quarterly instalment by multiplying its instalment rate by its instalment income for the quarter. The instalment rate is either the one given by the Commissioner or one chosen by the taxpayer, although the general interest charge may be payable if an instalment based on the taxpayer’s instalment rate is too low. Monthly instalments A taxpayer will generally be required to make monthly PAYG instalments if they have a base assessment instalment income of $20m or more and they are one of the following: • corporate tax entity (eg companies) • superannuation fund • trust • sole trader • large investor. However, such entities that lodge their GST quarterly or on an annual basis will only be required to pay monthly if its threshold is at least $100m and it is not a head company to a consolidated group or a provisional head company of a multiple entry consolidated group. A head company of a consolidated group or a provisional head company of an MEC group will be a monthly payer if their threshold amount is equal to or greater than the $20m threshold, regardless of the GST reporting requirements. An entity cannot object to being required to make instalments on a monthly basis. The amount of the instalment is generally calculated as the instalment income for the month multiplied by the instalment rate. However, there is an additional simplified method for calculating the instalments that may be applied unless the entity is notified by the ATO that it cannot use that method. This simplified method allows for the taxpayer to make a reasonable estimate of the instalment income for the first two months of a quarter to which it can apply the instalment rate. In the third month of each quarter the taxpayer calculates the total instalment income for the quarter and subtracts the estimates used in the first two months. The payment in the third month will be the balance remaining for the quarter, multiplied by the applicable instalment rate. A monthly instalment is due on or before the 21st day of the following month, or, if the entity is a deferred business activity statement (BAS) payer, by the 28th of the following month. All monthly PAYG instalments must be lodged and paid electronically. Annual instalment A taxpayer who is otherwise liable to pay quarterly instalments and meets certain requirements at the end of the first quarter for which an instalment would otherwise be payable can choose instead to pay one

annual PAYG instalment. Two of those requirements are that the taxpayer is neither registered, nor required to be registered, for GST, and that the notional tax most recently advised to the taxpayer by the Commissioner (ie a modified latest assessed tax) is less than $8,000. The taxpayer must notify the Commissioner of this choice, in the approved form, on or before the due date for the first quarterly instalment. The amount of an annual instalment is generally calculated by multiplying the Commissioner’s instalment rate by the taxpayer’s instalment income for the income year. Unlike the calculation of quarterly instalments, the taxpayer cannot choose an instalment rate. Alternatively, the taxpayer can choose to pay as its PAYG annual instalment either the notional tax amount most recently notified by the Commissioner (ie a modified tax on the most recently assessed taxable income) at least 30 days before the instalment due date, or the taxpayer’s estimate of the current year’s tax liability net of PAYG withholding credits (benchmark tax). If the taxpayer’s estimate of annual or quarterly tax payable is inaccurate, penalties may apply. Example In 2019/20, Miguel derived $25,000 salary, $20,000 business income and $2,000 interest. He incurred $5,000 in business expenses. On 31 August 2019, the Commissioner gives Miguel an instalment rate of 29.07%. Miguel is therefore liable to pay PAYG instalments for 2020/21. At 30 September 2020, Miguel is not registered, nor required to be registered, for GST, and the notional tax amount most recently notified to him by the Commissioner is $5,000 (in relation to 2020/21). Miguel is therefore eligible to pay an annual PAYG instalment and notifies the Commissioner on 30 September 2020 that he chooses to pay an annual instalment. On 1 April 2021, the Commissioner notifies Miguel that his notional tax amount in relation to 2020/21 is $5,100. While Miguel considers the Commissioner’s instalment rate too high he does not choose to estimate his benchmark tax for 2020/21. Miguel’s annual PAYG instalment for 2020/21 is therefore $5,100. Upon lodgment of his 2020/21 tax return he will be entitled to refund for any tax overpaid.

¶1-115 Failure to quote TFN to investment body Every taxpayer can apply to the ATO for a TFN. The TFN system enables the ATO to match income disclosed in tax returns with information obtained from other sources. Investors who make certain types of investments should quote their TFN (or, in the case of a business investment, their ABN — ¶1-120) to the investment body, otherwise the investment body must generally withhold an amount on account of tax from any income payable on the investment. The amount withheld is 47% of the payment being the top marginal rate plus the Medicare levy. A credit for the amount withheld is allowed on assessment. The TFN quotation rules apply to, for example: • interest-bearing accounts and other deposits with banks and other financial institutions • loans to government bodies and companies • units in unit trusts • shares in public companies • notionally accrued interest on deferred interest investments (but the investment body can recover the withheld amount from the investor). Exemptions from TFN rules Exemptions from the TFN rules apply in regard to: • accounts or deposits with financial institutions where the annual interest is less than $120 (although exploitation of the threshold may be an offence). This annual limit may be increased to $420 in some situations where the investor is under 16 years of age • people receiving age or other specified social security pensions

• dividends or interest received by non-residents that are subject to withholding tax • fully franked dividends on shares in public companies.

¶1-120 Australian Business Number The Australian Business Number (ABN) is a business identifier which facilitates businesses’ dealings with the government. To get an ABN, an entity must apply to be registered on the Australian Business Register. The Commissioner is the Registrar. An ABN is available to companies, government entities, other entities carrying on an enterprise in Australia, and other entities required to register for the GST. Activities as an employee do not constitute an enterprise. The following examples illustrate the significance of ABNs under the tax laws: • an entity required to register for the GST must have an ABN • quoting an ABN can ensure that certain payments are not subjected to PAYG withholding (¶1-105) • ABNs are used by businesses in business activity statements notifying the ATO of their obligations to make periodic tax payments, such as GST, PAYG withholding, PAYG instalments and fringe benefits tax (FBT) instalments (¶1-090) • charities seeking tax exemption and entities seeking deductible gift recipient status must obtain an ABN.

WITHHOLDING TAX ON DIVIDENDS, INTEREST AND ROYALTIES ¶1-150 Dividend, interest and royalty withholding tax Non-residents who derive dividends, interest or royalties from residents are generally liable to pay income tax as a withholding tax on the gross amount of that income at specified flat rates. The withholding tax provisions extend to interest and royalties derived by residents in carrying on business through a permanent establishment overseas which is paid by: • another resident and it is not wholly incurred by the payer in carrying on a business in a foreign country through a branch in that country, or • a non-resident and it is wholly or partly incurred in carrying on business in Australia through a branch. Withholding tax is a final tax liability on the income and is collected by way of PAYG withholding by the payer. Income on which withholding tax is payable is not included in the recipient’s assessable income. Exclusions from withholding tax There are significant exclusions from the withholding tax provisions. For example, franked dividends are generally not subject to withholding tax. Nor are interest payments on borrowings raised outside Australia by means of publicly offered debentures. Interest and royalties are not liable to withholding tax if the interest is derived by a non-resident carrying on a business in Australia at or through a permanent establishment in Australia. Rates of withholding tax Where dividends (generally unfranked dividends), interest or royalties are subject to withholding tax, the rates are generally as shown in the following table. No DTA*

DTA*

Dividends

30%

15% (generally)

Interest

10%

10%

Royalties

30%

10% (generally)

* A double taxation agreement between Australia and the non-resident’s country of residence.

ASSESSABLE INCOME AND EXEMPT INCOME ¶1-250 Annual basis of taxation Taxable income for an income year is calculated by subtracting from assessable income all deductions. Assessable income includes income according to ordinary concepts derived during the income year. The calculation of tax payable for a year therefore depends not only on whether certain income is derived but also on when the income is derived. In addition, progressive marginal tax rates for individuals mean that the timing of income derivation can have a significant effect on the total amount of tax payable over two or more years. When is income derived? The time at which income is derived can vary according to the nature of the income and the incomeearning activities of the taxpayer. For example: • salary or wages, directors’ fees, interest derived by an individual and rent are generally derived when received. Income that is not actually received can be constructively received, and therefore be deemed to be derived. An example is where interest is credited on a savings bank deposit • trading income is generally derived when the right to receive it arises as a debt due and owing • a professional person assessed on an accruals basis is taken to have derived fees when a recoverable debt is created by, for example, sending an account to the client • the yield from discounted or other deferred interest securities with terms exceeding 12 months is assessed as the income accrues over the term rather than when received on maturity • dividends are included in the assessable income of a shareholder when they are paid, credited or distributed to the shareholder. A dividend is therefore taxable in the year the dividend cheque is posted to the shareholder even though the cheque is not received until the following year. A dividend in the form of fully paid bonus shares is included in assessable income when the bonus shares are issued. Example On 30 June 2021, Magnus received a wages payment of $2,000 (one week in advance, one week in arrears), and rental income of $1,000 from his rental property (payment is required on the last day of the month for the following month). He has a term deposit for which the term expires on 30 June 2021. However, the bank does not credit his cheque account with the interest until 2 July 2021. On 2 July 2021, he also receives a dividend cheque of $500 which was posted by the company on 30 June 2021. Magnus’ assessable income for 2020/21 includes the: • full $2,000 of the wages payment • rental income of $1,000 • dividend of $500. The interest will form part of Magnus’ assessable income for 2021/22.

¶1-255 Assessable income Assessable income consists of ordinary income and statutory income, although some ordinary income and some statutory income can be exempt income. Exempt income is not assessable income. The assessable income of an Australian resident (¶1-550) includes ordinary income and statutory income from all sources (¶1-555), whether in or out of Australia, during the income year. The assessable income of a non-resident includes ordinary income and statutory income from Australian sources only.

The GST payable on a taxable supply is excluded from the supplier’s assessable income and exempt income. It falls into another category called non-assessable non-exempt income. Ordinary income Ordinary income is income according to ordinary concepts. The characteristics of income according to ordinary concepts, such as regularity of receipt, have been identified in decided cases over many years. Earnings from personal services, business receipts, interest and rents are examples of ordinary income. Special provisions of the law sometimes modify the way in which ordinary income is included in assessable income. For example: • annuities are included in assessable income under a provision that excludes from assessable income the part of the annuity that represents the return of a portion of the purchase price of the annuity. The excluded amount is calculated in accordance with a formula contained in the provision • a non-cash business benefit may be treated as ordinary income even if it is not convertible into money (convertibility into money being a usual condition of an amount being ordinary income), provided the benefit is otherwise of an income nature. A non-cash business benefit arises when property or services are provided to a business taxpayer in connection with a business relationship. Income versus capital Receipts of capital, such as a gain on disposal of an asset, are not ordinary income, and are therefore not assessable income unless included as statutory income as, say, a component of a net capital gain under the capital gains tax (CGT) provisions (see Chapter 2). A lump sum received on commutation of a superannuation pension or annuity, for example, would not be ordinary income, although the special provisions dealing with ETPs may treat some part of the lump sum as statutory income. In characterising a receipt as capital or income, it is the character of the amount in the hands of the recipient that matters. A payment that is income in the hands of the recipient may nevertheless be a capital payment, and therefore not a tax deduction, for the payer. Statutory income An amount is statutory income if it is not ordinary income but is included in assessable income by a specific provision of the income tax law. For example, a special provision includes in assessable income an amount that is a royalty in the ordinary sense of the word but is a capital receipt rather than income according to ordinary concepts. Such an amount is statutory income.

¶1-260 Exempt income If an amount is exempt income, it is not assessable income and therefore not taxable. Net exempt income (see below) can reduce the amount of a tax loss incurred in an income year and also reduce the extent to which a tax loss is available for set off against assessable income of a later income year. Exempt income is made up of: • ordinary income or statutory income that is made exempt by a provision of the law • ordinary income that the law excludes, expressly or by implication, from being assessable income (and is not non-assessable non-exempt income). Some examples of exempt income are: • some pensions paid under foreign laws that are, broadly, related to enemy persecution during the Second World War or to disability arising from participation in a resistance movement during that war • periodic maintenance payments to a spouse or former spouse • earnings of a resident taxpayer from at least 91 days’ continuous employment in a foreign country, including in some cases earnings that are also exempt from income tax in the foreign country, provided the income is earned as: – an aid or charitable worker employed by a recognised non-government organisation

– a government aid worker, or – a government employee deployed as a member of a disciplined force. • some scholarships and bursaries received by full-time students. Net exempt income A person’s net exempt income for an income year is the excess of total exempt income for the year over the sum of the losses and outgoings (other than capital ones) incurred in deriving the exempt income and any foreign taxes payable on that exempt income. Net exempt income may reduce the amount of current year or carry forward losses available to a taxpayer. Non-assessable non-exempt income Non-assessable non-exempt income is a third category of income recognised by the income tax law. Nonassessable non-exempt income is ordinary or statutory income that is expressly made neither assessable income nor exempt income. As non-assessable non-exempt income is not assessable income, it is not taken into account in working out a taxpayer’s taxable income for an income year. As the amount is also not exempt income, it is not taken into account in working out a taxpayer’s tax loss for an income year or in working out how much of a prior year tax loss is deductible in an income year. Some examples of non-assessable non-exempt income are: • the GST payable on a taxable supply • amounts subject to family trust distributions tax • foreign-sourced ordinary income derived by a temporary resident • dividends, interest and royalties that are subject to withholding tax when derived by non-residents • exempt payments made by mining companies for the benefit of Aborigines or Aboriginal representative bodies • cash flow boost subsidy provided to employers in response to COVID-19.

¶1-265 Income from personal services and pensions Earnings from providing personal services, whether under a contract of employment or some other contract for services, are assessable income. Assessable amounts include salary and wages, long service leave pay, directors’ fees and commissions. The earnings are assessable in the year of receipt, not necessarily in the year in which the services are provided. The following benefits are not assessable income: • an employer’s contributions to a complying superannuation fund for an employee’s benefit. The contributions are deductions for the employer and taxable in the hands of the fund (although taxpayers with combined income and concessional superannuation contributions in a year exceeding $250,000 are personally taxed an additional 15% on those concessional contributions — see ¶4-225) • benefits received by employees for frequent flyer points accumulated as a result of travel paid for by the employer. The reason is that the benefit does not arise from the employment relationship (where a non-cash benefit does arise from an employment relationship, the value of the benefit is generally subject to the FBT provisions (¶1-090) and is not included in the employee’s assessable income) • amounts received from pastimes, hobbies or windfall gains, including general gambling and lotto wins • gifts that are not related to personal services.

Alienation of personal services income Individuals are prevented from reducing or deferring their income tax by diverting their personal services income through a company, partnership or trust. Any diverted personal services income is included in the assessable income of the individual who performs the services, after allowing for certain costs incurred by the interposed entity. This rule does not apply where the interposed entity derives the income from conducting a personal services business or the income is promptly paid to the individual as salary or wages. Employee share acquisition schemes Benefits in the form of discounts on shares or rights acquired under an employee share acquisition scheme are taxed under special provisions. The rules have changed over time depending upon the date of acquisition of the shares or rights. The following applies to shares or rights acquired from 1 July 2015. The general rule is that a discount (being the market value less consideration paid) received on a share or right is included in assessable income in the year of acquisition. This general rule does not apply and the tax will be deferred until a later time where: • the shares are acquired under a capped salary sacrifice scheme under which an employee can obtain no more than $5,000 worth of shares and there is no real risk of the forfeiture of those shares • the shares or rights are acquired under a scheme for which there is a real risk of forfeiture of the shares or rights • the rights are acquired under a scheme that does not contain a real risk of forfeiture provided the scheme rules state that tax deferred treatment applies and the scheme genuinely restricts an employee from immediately disposing of the rights. The deferral is only available where the scheme meets certain qualifying conditions. Where the deferral applies, the discount is included in the recipient’s assessable income at the earliest of the following times: • in the case of a share, there is both no longer a real risk of losing the share and no restriction preventing the taxpayer from disposing of the share • in the case of a right, when there are no longer any genuine restrictions on the disposal of the right and there is no real risk of the taxpayer forfeiting the right, or the time when the right is exercised and there is neither a real risk of the taxpayer forfeiting the resulting share or a genuine restriction on the disposal of the resulting share • cessation of employment, and • the end of 15 years after the acquisition of the share or right. In addition, an exemption of $1,000 is available to be claimed by a taxpayer that is required to include the discount in their assessable income in the year of acquisition, if certain conditions are met and the individual has an adjusted taxable income (see ¶1-355) of less than $180,000. Further, in relation to interests received in certain small start-up companies, the taxpayer may be eligible for: • in relation to certain shares — an income tax exemption for the discount received. The shares will be subject to CGT provisions with a cost base reset at market value, and • in relation to certain rights — the deferral of income tax on the discount. The rights will be taxed under the CGT provisions with the rights having a cost base equal to the taxpayer’s cost of acquisition. Any shares acquired pursuant to the exercise of such rights are treated as having been acquired at the time the rights were acquired for determining whether the shares have been held for at least 12 months to apply the CGT discount.

Dividend equivalent payments A “dividend equivalent payment” is a cash payment paid by a trustee of a trust funded from dividends (or income from other sources) on which the trustee has been assessed in previous income years because no beneficiary of the trust was presently entitled to the income. The amount of the dividend equivalent payment is usually calculated by reference to the amount of the dividends (or other income) received by the trustee during a certain period, less the amount of tax paid by the trustee on that income. A dividend equivalent payment paid by a trustee under an employee share scheme is assessable to an employee as ordinary income where the payment has a sufficient connection with the employee’s employment, according to Taxation Determination TD 2017/26 (which applies to dividend equivalent payments paid under the terms and conditions attached to ESS interests granted on or after 1 January 2018). The circumstances in which the Commissioner accepts that a dividend equivalent payment is not for, or in respect of, services provided as an employee, and therefore is not assessable to an employee as remuneration under s 6-5, are contained in Appendix 2 to TD 2017/26. For further information on employee share schemes, see ¶10-470. Pensions Most social security and veterans’ entitlement pensions paid to people of pensionable age are assessable income, but a tax offset is available. For details of the Senior Australians and pensioner tax offset (SAPTO), see ¶1-355. Certain war-time persecution pensions are exempt from tax (¶1-260). The tax treatment of annuities and superannuation pensions is outlined at ¶1-290 and covered in detail at ¶16700. Termination of employment If an employee is paid an amount in consequence of the termination of employment, the amount is generally taxable under special rules applicable to ETPs. Termination payments that are excluded from ETP treatment are dealt with at ¶1-285, eg the tax-free amount of a genuine redundancy payment or an early retirement scheme payment. The special rules that apply to payments in lieu of unused annual leave and payments in lieu of unused long service leave are outlined below. Payments in lieu of unused annual leave A payment that is in respect of unused annual leave and made in consequence of retirement from, or the termination of, employment is assessable in full and taxed at normal marginal rates. If, however, the payment is for leave accrued in respect of service before 18 August 1993 or the payment is made under an approved early retirement scheme, or as a consequence of bona fide redundancy or invalidity, a tax offset ensures that the rate of tax payable on the payment does not exceed 30% plus Medicare levy. Payments in lieu of unused long service leave Amounts paid in respect of accrued long service leave in consequence of retirement from, or the termination of, employment are included in assessable income and taxed in accordance with the following table. Amount included in assessable income

Rate of tax

(a) 5% of amount paid in respect of long service leave that accrued before 16 August 1978

Normal marginal rates

(b) Whole amount paid in respect of long service leave that accrued after 15 August 1978 and also paid in respect of a bona fide redundancy or invalidity or an approved early retirement scheme

Not greater than 30% plus Medicare levy*

(c) Whole amount paid in respect of long service leave that accrued between 16 August 1978 and 17 August 1993 inclusive and not covered by (b)

Not greater than 30% plus Medicare levy*

(d) Whole amount paid in respect of long service leave that accrued after 17 August 1993 and not covered by (b)

Normal marginal rates

* A rebate of tax applies to limit the rate.

Payments made in respect of unused long service leave on the death of a person are exempt from tax if paid directly to the person’s beneficiaries or to the trustee of the deceased’s estate. Example Johan voluntarily retired on 16 August 2020 from the company he had worked for since 16 August 1977 (43 years). He was paid $100,000 in respect of his unused long service leave accrued over the employment. This payment will be taxed as follows (for simplicity, years have been used to allocate the payments, rather than days): Amount before 16 August 1978 1/43 × $100,000 = $2,325 $116 (ie 5% × $2,325) included in taxable income and taxed at marginal rates (plus Medicare levy) Amount between 16 August 1978 and 17 August 1993 15/43 × $100,000 = $34,884 $34,883 to be included in taxable income and taxed at marginal rates but not more than 30% (plus Medicare levy) Amount after 17 August 1993 27/43 × $100,000= $62,791 $62,791 to be included in taxable income and taxed at marginal rates (plus Medicare levy).

¶1-270 Income from investments Assessable income of resident individuals generally includes amounts derived as dividends, interest or rents and most returns from holding other investments such as units in unit trusts. The various kinds of investments and the returns on those investments are discussed in detail in Chapter 9. The gearing of investments is discussed in Chapter 11. Deductions for expenditure incurred in connection with the derivation of investment income are discussed at ¶1-325. Dividends Resident shareholders are assessable on dividends paid out of any company profits, including capital profits and profits that are exempt from tax. Dividends include any distributions made by a company to its shareholders, including certain distributions made in a return of capital. A reversionary bonus on a life assurance policy is not a dividend. Nor, generally, are bonus shares issued on or after 1 July 1998. Dividends are included in the assessable income of a shareholder when they are paid, credited or distributed to the shareholder. Therefore, a dividend is taxable in the year the dividend cheque is posted to the shareholder even though the cheque is not received until the following year. Payments or loans by private companies to shareholders or associates may be deemed to be payments of dividends, as may excessive remuneration for the services of past or present shareholders or associates. The taxation of companies and the operation of the company imputation system are covered at ¶1-400 and ¶1-405. Franked dividends Where a franked dividend is paid to a resident individual shareholder, the consequences are: • both the dividend and the amount of the attached franking credit (reflecting tax paid by the company) are included in the shareholder’s assessable income • the shareholder is entitled to a franking offset equal to the franking credit • the offset can be set off against tax on any income, but not against the Medicare levy. Any excess credits are refundable. Where franked dividends are received through trusts and partnerships, the franking credits and corresponding franking rebates are generally apportioned between the beneficiaries or partners according to their share in the net income or loss of the partnership or the net income of the trust. Where permitted by the trust deed, franked distributions can be streamed for tax purposes if beneficiaries are made

“specifically entitled” to those amounts. The concept of “specifically entitled” is discussed further at ¶1505. Note that where the trust is a discretionary trust a family trust election may be required to allow the benefit of the franking credits to flow through to the relevant beneficiaries. The law contains a rule to deter companies from the practice of “streaming” dividends in a way that ensures that franking credits are received by shareholders who benefit most. See also the discussion of the Pt IVA general anti-avoidance provisions at ¶1-610. Franked dividends paid to non-residents are not included in the non-resident’s assessable income and are generally exempt from withholding tax. Unfranked dividends paid to non-residents are not generally included in assessable income but are liable to withholding tax. Example Frank received a $3,000 dividend that was fully franked dividend at the 30% rate on 1 October 2020 with attached imputation credits of $1,286. Aside from the dividends, he made a loss during the year due to a negatively geared investment. In respect of the dividend, Frank includes $4,286 in his taxable income (dividend amount and imputation credit). After including the negatively geared investment, Frank has a taxable income of $1,000. The tax payable on Frank’s taxable income is nil. He is therefore entitled to a refund of the whole of the imputation credit of $1,286.

Interest For most taxpayers interest from any source is generally assessable income when it is received, although that rule is modified in detailed guidelines issued by the Commissioner about when interest is derived by financial institutions. An amount of interest that is made available to the lender — such as interest on a fixed deposit that is added to the capital — is regarded as received, and therefore assessable, even though it has not actually been received. Special rules There are many specific rules (both interpretative and legislative) that either exclude interest from assessable income or declare when it is derived and by whom. For example: • interest is not generally assessable where a person is not entitled to interest on a savings account that is set off against the person’s mortgage account under an “interest offset” arrangement • interest on joint bank accounts is assessable according to the beneficial interests of the account holders. The beneficial interests will be assumed to be equal unless there is evidence to the contrary • interest on a child’s savings account is assessable to the parent if the parent provided the money and controls the use of the interest. If the money in the account really belongs to the child, the child is taxed on the interest • special rules apply to the interest and other unearned income of minors (¶1-070) • income in the form of the deferred yield on certain discounted and deferred interest securities is taxed as the deferred yield (the excess of the redemption price over the issue price) accrues rather than when it is received on redemption of the security. The security must have an expected term of more than a year and a deferred yield greater than an amount equivalent to 1.5% of the redemption price for each year of the term of the security • interest derived from Australia by a non-resident is generally subject to a final withholding tax at a flat rate of 10%. If the interest is paid as an outgoing of an overseas business, withholding tax is not payable. If withholding tax is payable, the interest is not included in the non-resident’s assessable income • deemed interest on cash holdings or low interest bank accounts that is taken into account for social security purposes is not assessable income. Rents

Rental income is generally assessable when received. Co-owners of property are generally assessable according to their legal interests in the property. Unit trusts and other investment funds Distributions out of income of a unit trust are assessable income of the unitholder, generally in the year in which the income is derived by the trust rather than the year in which the distribution is made. A distribution out of capital would not be assessed to the unitholder unless the amount was included in assessable income of the trust, eg as a net capital gain under the CGT provisions, or it gave rise to a taxable capital gain pursuant to CGT event E4 in the hands of the beneficiary. The taxation of trust income is discussed at ¶1-500 and following. The taxation of capital gains is discussed at ¶1-295 and in Chapter 2. Any ongoing commission paid by an investment fund to an investment adviser in relation to an investor’s investment in the fund is considered to be assessable income of the investor if the adviser is under an obligation to pass the commission on to the investor. The income earned on amounts contributed by a taxpayer or an employer of a taxpayer to a superannuation or rollover fund or to a retirement savings account (RSA) is assessable income of the fund or RSA provider and not the taxpayer. The taxation of this income is discussed in Chapter 4.

¶1-275 Transactions in property and securities, other financial dealings and life assurance Property The proceeds of the sale of an asset do not give rise to assessable income if the taxpayer is merely realising the asset, even in the most advantageous way. If, however, the activities surrounding the sale constitute a business venture or profit-making undertaking, eg an extensive program of developing land for sale, the profit on sale is assessable income. In both situations the CGT provisions (¶1-295) may apply if the asset was acquired after 19 September 1985, but only to the extent that the gain is not assessable under other parts of the law. The gain may be smaller under the CGT provisions for an individual, trust or complying superannuation fund because the gain is discounted. Property investments are discussed at ¶9-310. Securities Any gain on the disposal or redemption of a security that is: • not indexed, does not bear deferred interest • issued at no, or a low, discount, is assessable in the year of disposal or redemption. Examples of such securities are debentures, bills of exchange, bank accounts, fixed deposits and other debt instruments (¶9-110 and following). The gain is not subject to the CGT provisions. A loss on disposal or redemption of such a security is generally a deduction in the year of disposal or redemption. For securities issued after 7.30 pm 14 May 2002 that convert or exchange into ordinary shares, no gain or loss arises from the disposal or redemption of the security in two specified circumstances. This means an investor who holds a relevant financial instrument through conversion or exchange will not be subject to tax until it is ultimately sold. Gains from the mere realisation of other securities or of shares are not assessable as ordinary income, although the CGT provisions may apply to all or part of the gain. If shares are sold cum dividend, the purchaser is assessable on the dividend when paid. Foreign exchange gains and futures profits A foreign exchange gain is assessable as ordinary income where, for example, a liability incurred in a foreign currency is discharged and the liability was for the purchase of trading stock or where a profit is made from speculating in currency variations. Foreign currency gains and losses are brought to account when realised, regardless of whether there is

an actual conversion of foreign currency amounts in Australian dollars. Financial institutions are exempt from the application of these rules. Foreign currency gains and losses are treated as having a revenue character, subject to limited exceptions where the foreign currency gain or loss is closely linked to a capital asset. Foreign exchange gains of a private or domestic nature are only assessable in limited circumstances. Profits from speculative dealings on the futures market are also generally assessable as ordinary income. Futures are discussed at ¶9-335. Life assurance Life assurance or endowment policies are assessed as follows: • the lump sum proceeds of life assurance or endowment policies are not assessable income, whether received on maturity, forfeiture or surrender of the policy • amounts received as bonuses, other than reversionary bonuses, on life assurance policies are assessable income • if the risk under a policy commenced after 7 December 1983, reversionary bonuses are assessable in full if received within eight years of the commencement of the risk. Two-thirds of any reversionary bonus received in the ninth year is assessable as is one-third of any such bonus received in the 10th year. Amounts assessable under these attract a tax rebate of 30% which can be set off against the tax otherwise payable on income from any source. Insurance bonds are discussed at ¶9-600.

¶1-280 Partnership and trust income Partners in partnerships are assessable in their individual capacities on their shares of the net income of the partnership. Similarly, beneficiaries of trusts who are presently entitled to a share of the income of a trust are assessable in their individual capacities on their share of the net income of the trust. The income is included in the individuals’ assessable incomes of the income year in which the partnership or trust derives the income, whether or not the amounts have been distributed. Partnerships and trusts are discussed at ¶1-450 and ¶1-500 respectively. The gross proceeds of a business are assessable income. For example, where the sales and purchases of shares are sufficient to constitute the carrying on of a business, the shares would then be trading stock (¶1-300) and, if unsold, would have to be brought to account at the beginning and end of each income year in working out taxable income. Proceeds of the sale of such shares would be included in assessable income and not subject to CGT.

¶1-283 Small business entities Small business entities (ie entities that are carrying on a business during the year of income that satisfy the relevant “aggregated turnover” test) are entitled to tax advantages of special income tax concessions and CGT concessions. The aggregated turnover threshold for the concessions is generally $10m. However, different thresholds apply for the following: • the CGT small business concessions to which a $2m threshold applies (see ¶2-300), and • the small business tax offset to which a $5m threshold applies (see below). Small business tax offset Individuals deriving income from an unincorporated small business are entitled to the “small business tax offset” which effectively provides a discount on the income tax payable on that business income subject to a maximum cap of $1,000 per year (see ¶1-283; ITAA97 Subdiv 328-F). The discount is 13% for unincorporated small business entities with an aggregated annual turnover of less than $5m in 2020/21. An individual is entitled to the small business tax offset for an income year where either:

• the individual is a small business tax entity for the income year (eg sole trader), or • has assessable income for the income year that includes a share of the net income of a small business entity that is not a corporate tax entity (eg a trust or partnership). The amount of the offset is equal to 13% of the following: The individual’s total net small business income for the income year The individual’s taxable income for the income year

×

The individual’s basic income tax liability for the income year

For these purposes, the individual’s total net small business income for the income year means so much of the sum of the following that does not exceed the individual’s taxable income for the income year: • where the individual is a small business entity — the individual’s net small business income for the income year, and • the individual’s share of a small business entity’s net small business income for the income year that is included in assessable income (excluding that of a corporate tax entity) less relevant attributable deductions to that share. An entity’s net small business income is the result of: • the entity’s assessable income for the income year that relates to the entity carrying on a business disregarding any net capital gain and any personal services income not produced from conducting a personal services business • LESS: the entity’s relevant attributable deductions attributable to that share of assessable income. If the result is less than zero, the net small business income is nil. Relevant attributable deductions are deductions attributable to the assessable income other than taxrelated expenses, gift and contributions or personal superannuation contributions under Subdiv 290-C. The discount rate will increase to 16% in 2021/22 but the amount of the offset continues to be capped at $1,000. Instant asset write-off (special depreciation) A small business entity may elect to apply simplified depreciation rules. The simplified depreciation rules entitle a small business entity to claim an immediate tax deduction (also known as the instant asset writeoff) for the full cost of an asset provided it is less than the specified thresholds at the time the asset was purchased and first used, or installed ready for use. The relevant thresholds are as follows: Date range for when asset first used or installed ready for use

Threshold

12 March 2020 to 31 December 2020

$150,000

7.30 pm (AEDT) on 2 April 2019 to 11 March 2020

$30,000

29 January 2019 to 7.30 pm (AEDT) on 2 April 2019

$25,000

1 July 2016 to 28 January 2019

$20,000

For the acquisition of a car, the deduction under the instant asset write-off is subject to the car cost depreciation limit, being $57,581 for 2019/20 and $59,136 for 2020/21. The threshold for the instant asset write-off is due to revert to $1,000 with effect from 1 January 2021. Assets that are not entitled to the instant write-off must be included in a single depreciating pool with a diminishing rate of 30% (15% for the first year). A small business entity may also be entitled to

accelerated depreciation deductions up to 30 June 2021 where the instant asset write-off is not available (see ¶1-332). Note that the instant asset write-off is also available for businesses with aggregated turnover less than $500m up to 31 December 2020 (see ¶1-330). Other income tax concessions Small business entities may elect to take advantage of various income tax concessions including: • small business restructure rollover — an optional income tax and CGT rollover available for the transfer of assets as part of a restructure which involves a change of legal structure without a change in the ultimate legal ownership of the assets. • trading stock concessions — the entity is not required to undertake a stocktake or account for changes in the value of trading stock at the end of an income year where the change in value from the start to the end of the year is $5,000 or less. • prepayments — an entitlement to an immediate deduction for certain prepaid expenditure. • start-up costs — an immediate deduction for professional expenses that are associated with starting a new business. • FBT exemption for multiple work-related portable devices.

¶1-285 Employment termination payments (ETPs) and superannuation lump sums The taxation of termination payments differs depending upon whether the payment is an employment termination payment (ETP) or a superannuation lump sum. ETPs

Superannuation lump sums

• “life benefit termination payments” received in consequence of termination of employment, eg on resignation, retirement, redundancy or invalidity, including “golden handshakes” (¶14-250)

• payments from superannuation funds or RSAs, excluding payments such as pensions (¶4-420)

• “death benefit termination payments” received in consequence of termination caused by death (¶14-250)

• payments from ADFs (¶4-420)

Payments that are not ETPs Payments that are not ETPs include payments in lieu of unused annual leave or unused long service leave (¶1-265). Genuine redundancy payments and early retirement scheme payments paid after 30 June 1994 up to certain limits are tax-free and not ETPs. The limit for 2020/21 is $10,989 plus $5,496 for each completed year of service. Any amount over this limit is taxed as an ordinary ETP. The taxation of life benefit termination payments Life benefit termination payments may be subject to concessional rates of tax if: • the amount is taken in cash, and • it is received within 12 months of the termination (unless it is a genuine redundancy payment or the Commissioner allows a longer time). ETPs are not able to be paid into superannuation. Life benefit termination payments from employers are comprised of the following two components: • a tax free component, and

• a taxable component. The tax free component comprises any invalidity amount and the pre-July 1983 amount. This component is non-assessable, non-exempt income and therefore not subject to tax. The invalidity segment is calculated as the portion of the payment that represents the period between termination and the person’s last retirement day. An ETP contains an “invalidity segment” if: • the payment was made to the person because they can no longer work because of ill health • the person stopped working before they reached their last retirement day, and • two medical practitioners have certified that it is unlikely the person can ever work again in a role for which they are qualified. The pre-July 1983 segment is calculated as the portion of the payment that represents the individuals’ service period prior to 1 July 1983. The taxable component is the whole of the termination payment amount reduced by the tax free component. Where there is no invalidity component, this will be the post-June 1983 component. The taxable component is included in assessable income. However, a tax offset may be available to limit the effective tax payable as detailed below plus the Medicare levy. The calculation of the tax offset depends on the type of ETP paid. The ETP cap applies to a: • payment pursuant to an early retirement scheme or bona fide redundancy (part exceeding the tax free component) • compensation payment for personal injury, unfair dismissal, harassment or discrimination • payment because of an employee’s permanent disability, and • lump sum payment paid on the death of an employee. In 2020/21, the taxable component of an ETP subject to the ETP cap is as follows: Amount of benefit

If recipient is aged 55 and over

If recipient is aged under 55

(column 1) ($)

Tax on column 1

% on excess (max marginal rate)**

Tax on column 1

% on excess (max marginal rate)

Nil

Nil

15

Nil

30

215,000

32,250

45

64,500

45

* Note that this cap is indexed for future years. This amount is available each time an employee receives an ETP from an employer, unless an ETP has already been received by the employee in that same year or in respect of the same termination. ** The rates set out in the table are the maximum marginal tax rates that apply. The Medicare levy may also be payable on the life benefit termination payments.

However, for all other ETPs (eg a golden handshake, gratuities, payment in lieu of notice or unused sick leave) the offset is the lesser of the ETP cap and the amount worked out under the whole-of-income cap. The whole-of-income cap limits the tax offset to that part of the ETP takes the person’s total annual taxable income (including the ETP) to no more than $180,000. The balance is taxed at the top marginal rate of tax. Example Dennis is made redundant from his position at Panache Power in August 2020 after working there for 13 years. He is 63 years old. He receives a payment of $300,000 in relation to his bona fide redundancy. There is neither a pre-June 1983 nor an invalidity segment included in the payment. Since Dennis’ other income for the year is $200,000 (and he is therefore in the top marginal tax

bracket), concessional rates will apply to the whole of the payment as the ETP relates to a genuine redundancy and only the ETP cap will apply. The tax he will pay on the ETP, excluding the Medicare levy is:

Amount

Maximum tax rate

Tax payable

Exempt component

$82,437

Nil

Nil

The ETP cap

$215,000

15%

$32,250

$2,563

45%

$1,153

Excess (balance of payment) Total tax payable

$33,403

Note that if the facts were different such that Dennis was merely terminated from employment, as opposed to receiving a bona fide redundancy, the payment would be subject to the whole-of-income offset. In such a case the whole of the payment would be subject to the top marginal tax rate of 45% (excluding Medicare levy) due to the whole-of-income cap of $180,000 being exceeded by the other income Dennis derived in the year.

The taxation of death benefit termination payments The taxation of death benefit termination payments is discussed at ¶4-420. Superannuation lump sums The taxation of superannuation lump sums depends upon whether the payment is from a taxed source or an untaxed source. A taxed source refers to payments made from complying superannuation funds and RSAs. An untaxed source refers to payments from an untaxed superannuation fund such as a state superannuation fund or a non-resident superannuation fund and also to payments directly from an employer. Taxation of superannuation lump sum benefit payments from a taxed source Lump sum benefits paid from a taxed source to an individual aged 60 or over are tax-free. Lump sum benefits paid from a taxed source to an individual who is below age 60 have two components: • a tax free component, and • a taxable component. The tax free component comprises the following components: • the “contributions segment”, which includes all contributions made since 1 July 2007 that have not been included in the assessable income of the superannuation provider, for example, the person’s non-concessional contributions, and • the “crystallised segment”, which is calculated by assuming that an ETP representing the full value of the superannuation interest is paid just before 1 July 2007. The crystallised segment contains the following previous elements: – the pre-July 1983 component: the proportion of a payment, excluding the above components, that relates to service before 1 July 1983. The method of apportioning a payment between service up to 30 June 1983 and service from 1 July 1983 is on a time basis, according to the eligible service period. Where a payment is from an employer-sponsored superannuation fund, the eligible service period is the combined periods of employment and fund membership. Where a payment is from a fund for the self-employed, the eligible service period is the period of fund membership. The pre-July 1983 component is calculated as the lesser of: (Total ETP – concessional – post-June 1994 invalidity component – excessive component – CGT-exempt)

×

pre-July 1983 service period total service period

OR (Total ETP – concessional – post-June 1994 invalidity component – excessive component – CGT-exempt)

−

Undeducted contributions

– the CGT exempt component: this amount arose out of the disposal of the assets of a small business (¶15-200) – the post-June 1994 invalidity component: this component was paid when disability caused employment to cease and resulted in the recipient being unlikely to be able to be employed in any capacity for which he/she was reasonably qualified – the concessional component: this component was paid from employer-sponsored superannuation funds up to 30 June 1994 and represented payments in relation to redundancy, approved early retirement schemes and invalidity, and – undeducted contributions up to 1 July 2007: the part of the ETP represented by superannuation contributions made after 30 June 1983 (other than by an employer) that were not income tax deductions of the contributor. The taxable component is tax-free up to the low-rate threshold of $215,000 for 2020/21 and taxed at a maximum rate of 15% above the threshold. For those under the age of 55, this component is taxed at a maximum rate of 20%. The taxed component currently comprises the following components: • the post-June 1983 component: which represents the total ETP reduced by all the other components, and • the non-qualifying component. Note that the Medicare levy may also be payable upon any superannuation benefit where a tax rate greater than zero per cent applies. Example Delores retired from her job at age 58 on 31 July 2020 and, having already a substantial private income, has decided to spend her accumulated retirement funds on a house in the country. She had a salary in 2020/21 of $150,000, private income consisting of interest of $50,000 and her superannuation payout is $290,000 (with an exempt component of $50,000 and a taxable component of $240,000). Her employer paid her a “golden handshake” of $5,000 with no exempt component. The taxation of Delores’ superannuation payout and “golden handshake” (excluding Medicare levy), and the amount she will be able to apply towards the cost of her house, are illustrated below.

Component amount

Assessable amount

$

$

– tax free component

50,000

Nil

– taxable component

240,000

ETP component

Tax rate applied

Tax payable*

ETP after tax

$

$

Nil

Nil

50,000

215,000

up to low rate cap (max rate): 0%

Nil

215,000

25,000

above low cap rate (max rate): 15%

3,750

21,250

Superannuation lump sum

Golden handshake – taxable component

5,000

5,000

$295,000

$245,000

marginal rate: 45%

2,250

2,750

$6,000

$289,000

*As Delores’ taxable income exceeds the whole-of-income cap of $180,000, the golden handshake is subject to marginal rates, not the concessional ETP rates.

Taxation of superannuation lump sum benefit payments from an untaxed source Lump sum benefits paid from an untaxed source to an individual aged 60 or over are taxed at the maximum rates shown in the following table for 2020/21. Amount of benefit (column 1) ($)

Tax on column 1

% on excess (max marginal rate)*

Nil

Nil

15

1,565,000**

234,750

45

* The rates set out in the table are the maximum rates excluding any applicable Medicare levy. The amount is included in the person’s assessable income for the year and an offset against tax payable is calculated to effectively reduce the marginal tax rate to the maximum applicable. ** The untaxed plan cap amount is indexed annually.

Lump sum benefits paid from an untaxed source to an individual being from preservation age to 59 are taxed at the maximum rates shown in the following table for 2020/21. Amount of benefit (column 1) ($)

Tax on column 1

% on excess (max marginal rate)*

Nil

Nil

15

215,000**

32,250

30

1,565,000***

437,250

45

* The rates set out in the table are maximum rates excluding Medicare levy. The amount is included in the person’s assessable income for the year and an offset against tax payable is calculated to effectively reduce the marginal tax rate to the maximum applicable. ** The low rate cap amount is indexed annually. It is $215,000 for 2020/21 ($210,000 for 2019/20). *** The untaxed plan cap amount is indexed annually. It is $1,565,000 for 2020/21 ($1,515,000 for 2019/20).

Lump sum benefits paid from an untaxed source to an individual younger than preservation age are taxed at the maximum rates shown in the following table for 2020/21. Amount of benefit (column 1) ($)

Tax on column 1

% on excess (max marginal rate)*

Nil

Nil

30

1,565,000

469,500

45

* The rates set out in the table are maximum rates excluding Medicare levy. The amount is included in the person’s assessable income for the year and an offset against tax payable is calculated to effectively reduce the marginal tax rate to the maximum applicable.

Note The $1,565,000 threshold in the above tables applies on a lifetime basis to each member of the fund.

It is also indexed to AWOTE and increases in amounts of $5,000. Note also that the Medicare levy is also payable upon any superannuation benefit where a tax rate greater than zero percent applies.

Rollover of superannuation benefits ETPs cannot be rolled into superannuation funds. Superannuation benefits, however, may be able to be rolled over and are not assessable to the extent they are rolled over into a complying superannuation fund or ADF, into an RSA or used to purchase certain annuities (including allocated annuities that comply with relevant standards) from a life office, friendly society, trade union or employee association. When funds are rolled over from an untaxed fund to a taxed scheme, the transferring untaxed fund must withhold tax at the top marginal tax rate for amounts above $1,565,000. The first $1,565,000 of the benefit transferred will be treated as a taxable contribution by the receiving fund, and the remainder will form part of the exempt component in the receiving fund and not be taxed further. Certain forms and documentation need to be maintained for a rollover of superannuation monies. These are discussed at ¶4-430.

¶1-290 Superannuation income streams The following table shows the maximum tax rates that apply to superannuation income streams. The Medicare levy is also payable upon any superannuation benefit where a tax rate greater than zero per cent applies. Age

Superannuation income stream — element taxed in the fund

Superannuation income stream — element untaxed in the fund

Aged 60 and above

– Tax-free

– Tax free component is tax-free – Marginal tax rates and 10% tax offset

Preservation age to age 59

Below preservation age

– Tax free component is tax-free

– Tax free component is tax-free

– Taxable component taxed at marginal tax rates with 15% tax offset

– Taxable component is taxed at marginal tax rates with no tax offset

– Tax free component is tax-free

– Tax free component is tax-free

– Taxable component taxed at marginal tax rates (no tax offset)

– Taxable component is taxed at marginal tax rates with no tax offset

– A disability superannuation income stream receives a 15% tax offset The tax treatment of superannuation income streams is covered in detail from ¶16-700 onwards.

¶1-295 Capital gains tax Where an asset acquired after 19 September 1985 is disposed of, the CGT provisions generally apply to any gain or loss on the disposal. If, however, a gain is assessable under some other provision, the CGT gain is reduced by the amount assessable under that other provision. Gains on the disposal of most depreciating assets are dealt with under the capital allowances provisions (¶1-330) and also under the CGT provisions where there is some private use.

The CGT provisions include in a taxpayer’s assessable income only the net capital gain for the income year. To calculate the net capital gain, the total of the taxpayer’s capital gains for the year (excluding any exempt gain by a small business taxpayer on an asset owned for 15 years) is first reduced by any capital losses made during the year. Any net capital losses from earlier years are then deducted. The result is further reduced by any discounts on particular gains and then by any concessions for small business taxpayers (see below). Individuals and trusts can apply the general CGT discount to their capital gains on assets owned for at least 12 months by the relevant percentage. The relevant percentage for individuals that have been Australian residents (other than temporary residents) for the whole period of ownership is 50%. The percentage rate is reduced to take into account any part of the ownership period during which an individual was a foreign resident or a temporary resident on or after 8 May 2012, subject to transitional rules. However, where the individual was either a foreign resident or a temporary resident as at 8 May 2012 and makes a capital gain from a CGT event after that date, the 50% discount is only available for any capital gain accrued up to 8 May 2012 provided the individual obtains a market valuation of the relevant CGT asset as at that date. If no valuation was obtained and the individual was a foreign resident or a temporary resident at all times since 8 May 2012, no discount will be available. The relevant percentage for trusts is 50%. The discount for complying superannuation funds is one-third. The gain to be discounted is worked out without indexation of the cost base of the asset. If the asset was acquired before 21 September 1999, the individual, trust or superannuation fund can alternatively choose to calculate a capital gain on the basis of the asset’s indexed cost base, but with indexation frozen at 30 September 1999. Companies are not entitled to discount their capital gains but are entitled to use the “frozen indexation” basis for assets acquired before 21 September 1999. As mentioned, trusts generally calculate their capital gains in the same way as individuals. Where permitted by the trust deed a capital gain may be streamed to a particular beneficiary by making them “specifically entitled” to the capital gain made by the trust. In this case the beneficiary is effectively treated as having made the capital gain. Alternatively, a trustee of a resident trust can choose to be assessed on a capital gain of the trust if no amount of the trust property referable to the capital gain is paid or applied for the benefit of a beneficiary. The concept of “specifically entitled” is discussed further at ¶1-505. To the extent that a beneficiary is not made specifically entitled to a capital gain and the trustee does not make the choice, the capital gain will be allocated to the beneficiaries of the trust on a proportionate basis in accordance with their present entitlement to the share of the trust income (after excluding amounts to which a beneficiary was made specifically entitled). Where the discount method is chosen by the trust, a beneficiary receiving a part of the gain is required to gross up the share of the gain to remove the effect of the discount and any discount under the CGT small business concessions before calculating the beneficiary’s net capital gain. The beneficiary’s net capital gain is calculated by including the grossed-up share of the gain from the trust with any other capital gains made during the year and deducting any current year and prior year capital losses. The beneficiary’s discount (if any) can then be applied to the grossed-up share of the trust’s capital gain included in the beneficiary’s net capital gain. The CGT provisions are very extensive and are covered in detail in Chapter 2. Some significant features are, however, mentioned here. Main residence and other exemptions The capital gain or loss on the disposal of a dwelling will be disregarded where the owner of the dwelling occupied it as their main residence throughout the period of ownership. If the dwelling was the main residence of the owner for only part of the period of ownership, only part of the capital gain or loss will be disregarded. However, the main residence exemption is not available for foreign residents from 9 May 2017, with grandfathering provisions available for properties held prior to that time and sold up to 30 June 2020. The main residence exemption is detailed in Chapter 12. The CGT provisions also do not apply to the disposal of most life assurance policies (eg on payout), private motor cars or trading stock or to gambling and lottery wins. Special rules apply to gains and losses on the disposal of assets kept for personal use such as works of art and jewellery. Disposal of small business assets Any entity that is a CGT small business entity or satisfies a maximum net asset value test may be entitled

to one or more of the four CGT concessions available for a capital gain arising on the disposal of an active asset owned by the entity. For CGT purposes, a CGT small business entity is an entity that carries on a business during the income year and which, generally speaking, has an “aggregated turnover” of less than $2m in either the previous or current income year. Alternatively, the concessions are available where the net value of all CGT assets of the taxpayer, “affiliates” and “connected entities” do not exceed $6m. The concessions are available to an individual, a company or a trust. A disposal of shares in a company or interests in a trust is potentially eligible for the concessions where the shares or interests themselves are active assets and certain ownership levels are satisfied. The CGT small business concessions are as follows: • The gain may be exempt if the asset was owned by the taxpayer for at least 15 years and occurs in relation to the retirement of the taxpayer or CGT concession stakeholder (as relevant) over the age of 55 or in the event of their permanent incapacitation. • The gain may attract a 50% exemption. The exemption applies to the gain remaining after any application of the general discount (see above). • The gain may be exempt if the capital proceeds are used in connection with the retirement of the taxpayer or a stakeholder (as relevant) up to specified limits. If the taxpayer or stakeholder is under 55, the gain must be rolled over to a complying superannuation fund or RSA. • A rollover may permit the gain to be deferred. The gain can be deferred for at least two years. A longer deferral will apply where the taxpayer acquires a replacement asset within a specified period. The gain is deferred to the extent that it does not exceed the cost base of the replacement asset. Non-resident CGT withholding A non-final withholding tax is imposed on the disposal of taxable Australian property (including indirect interests and options or rights to acquire such property) by a foreign resident, excluding where any of the following applies: • the relevant CGT asset has a market value of the asset less than $750,000 • the transaction is conducted through a stock exchange or a crossing system • the transaction is an arrangement that is already subject to an existing withholding obligation • the transaction is a securities lending arrangement, or • the transaction involves a vendor that is subject to formal insolvency or bankruptcy proceedings (TAA Sch 1 s 14-200; 14-215). The purchaser is required to withhold and remit to the ATO 12.5% (or such varied amount as approved by the Commissioner) of the proceeds from the sale. The withholding is required on or before the day the purchaser becomes the owner of the asset (usually at settlement) and must be paid to the ATO without delay. Assets passing on death A person’s death generally does not constitute a disposal of the person’s assets for CGT purposes. Where a person dies after 19 September 1985, the legal personal representative or beneficiary to whom an asset passes is deemed to have acquired it when the deceased died — at market value if the deceased acquired the asset before 20 September 1985, otherwise generally at the asset’s cost base at the date of the deceased’s death.

DEDUCTIONS

¶1-300 Annual basis of taxation Income tax is an annual liability worked out by reference to a taxpayer’s taxable income for an income year. Taxable income is calculated by subtracting from assessable income all general and specific deductions (¶1-305). The calculation of tax payable for a year therefore depends not only on whether expenditure is deductible but also on when the deduction is allowable. In addition, progressive marginal tax rates for individuals mean that the timing of deductions can have a significant effect on the total amount of tax payable over two or more years. Deduction when expenditure incurred A loss or outgoing is generally deductible in the income year in which the expenditure is incurred. Expenditure can be incurred without payment being made as long as the taxpayer is definitively committed to the payment and the expenditure is properly referable to the income year. Interest expenditure, for example, is a deduction in the income year in which the interest becomes due and payable. Deductions for expenditure incurred in advance of the provision of services are generally apportioned evenly over the period during which the services are to be provided. Trading stock Expenditure on acquiring trading stock of a business is deductible when the expenditure is incurred. The income tax law ensures, however, that the deduction is effectively deferred to the income year in which the trading stock is sold by taking unsold stock into account at the end of an income year and at the beginning of the next year. The amount taken into account excludes any GST input tax credit arising on acquisition of the stock. The shares of an individual who is a share dealer are trading stock, but shares that are merely held by the individual for resale at a profit are not trading stock. The land of a land dealer can also be trading stock. Small business entities do not need to account for small changes in the value of stock during an income year (¶1-280).

¶1-305 General and specific deductions The income tax law classifies deductions as general and specific. General deductions A general deduction is any loss or outgoing to the extent that it is incurred in gaining or producing assessable income, or is necessarily incurred in carrying on a business for income-producing purposes. A loss or outgoing may be deductible even though it does not produce assessable income in the year in which it is incurred. The loss or outgoing must, however, be expected to produce assessable income and have the essential character of an income-producing expense. A bad debt arising out of business activities of earlier years may be deductible despite the business having in the meantime ceased operations. Interest on business loans may also be deductible after the business ceases operations. Non-deductible losses or outgoings Examples of losses or outgoings that are not deductible are: • losses or outgoings of a capital, private or domestic nature (eg child care expenses) • losses or outgoings incurred in producing exempt income • expenditure incurred in producing the income of some other person. For example, interest on a loan taken out by a parent would generally not be deductible if the borrowed money was passed on interest-free to a daughter for use in her business to produce her assessable income • payments of income tax • interest on money borrowed to pay a personal income tax liability or a personal superannuation contribution.

Expenditure incurred both in producing assessable income and for private purposes needs to be apportioned into its deductible and non-deductible components. Specific deductions Some amounts are deductible under specific provisions of the law. These are called specific deductions. Some examples are deductions for repairs, prior years’ losses, a partner’s individual interest in a partnership loss and depreciation in respect of capital expenditure. Specific deductions are not necessarily in respect of expenditure related to income-producing activities, eg deductions for certain gifts (¶1-345). In addition, some specific provisions of the law either deny deductions that would otherwise be allowable or limit the amount of a deduction. For example, salary or wages paid to a relative (eg a spouse or child) or paid by a private company to a shareholder is not deductible to the extent that the payment exceeds a reasonable amount. As a further example, under the commercial debt forgiveness rules, a debtor whose debt is forgiven may be denied a range of deductions, such as in respect of all or part of a prior year’s loss.

¶1-310 Business deductions As mentioned above, a person carrying on business can deduct losses or outgoings that are necessarily incurred in carrying on the business to produce assessable income. The person carrying on the business is the best judge of what is necessary. The expenditure does not have to be unavoidable to qualify as a deduction. A person carrying on a profession or trade is in business. A person engaging in share trading, for example, may be in business but it would depend on all the facts. Some indicators are the scale of operations, the frequency of transactions, the profitability of the activities and whether the person conducts the activity full-time and keeps adequate records. Some examples of deductible business expenses are: • the usual recurring operating expenses of a business • the cost of keeping abreast of business trends • pay-roll tax, sales tax and FBT (¶1-090) — but not GST (to the extent entitled to an input tax credit), and • certain business-related capital expenditure is deductible on a straight-line basis over five years (eg expenditure to establish a business structure or expenditure to convert an existing business structure to a different structure). Some examples of non-deductible expenses are: • private travel and capital costs to expand a business structure • dividends paid by companies. Individuals are limited in offsetting losses from non-commercial business activity against other assessable income. Such losses can be offset against other income only if at least one of several statutory tests is satisfied, eg that the assessable income from the activity is at least $20,000. Notwithstanding the satisfaction of a statutory test a taxpayer is only able to apply a non-commercial loss where the taxpayer’s adjusted taxable income for the year is less than $250,000.

¶1-320 Employment and self-employment deductions Employees and self-employed persons are entitled to deductions for expenditure incurred in gaining or producing assessable income. Examples are: • the cost of renegotiating an employment agreement

• the cost of travelling between two or more different places of work (including, in the case of a selfemployed person, different locations of the same income-producing activity) • depreciation on computers and tablets used for work • technical journals • membership of unions or professional associations • tax return preparation and other professional tax advice • expenses of overseas travel by professional persons and academics, whether employees or selfemployed, to keep abreast of new developments or attend conferences • net self-education expenses exceeding $250 connected with the production of assessable income, but not if the study is directed at new income-producing activities. Some examples of non-deductible expenditure are: • expenses incurred by an employee in getting or changing jobs or moving to a job — because the expenditure is incurred too soon to be regarded as incurred in gaining or producing assessable income • child care expenses. Home office Where part of a home is set aside as an office, some part of the outgoings on the home may be deductible. If the home, or a particular part of it, is a real place of business (eg where a professional conducts a private consultancy practice in an area of the home that is set aside and used exclusively for that purpose, is clearly identifiable as a place of business visited by clients and is not readily adaptable for domestic use), the range of deductions is greater than if the person has a usual place of work away from the home and uses, exclusively, a part of the home as a convenient place to carry out some incomeproducing work. Where the home is a real place of business, deductions are generally available for: • a proportion of home loan interest, rates, house insurance, heating, lighting and maintenance • depreciation, insurance and repairs on equipment and fittings, such as desks, curtains and light fittings • work-related telephone calls from home and a proportion of the rental of the home telephone, but not the cost of installing a home telephone. If the home office does not qualify as a place of business, deductions are not available for home loan interest, rates or house insurance. Special shortcut provisions are available for deductions for working from home for the period from 1 March to 30 September 2020 (see ¶12-066).

Caution While deductions can normally be obtained for a portion of the running expenses for items such as telephones, heating and lighting, it may not be possible to secure deductions for connection fees for these items. Other occupancy expenses such as rates, home loan interest or house insurance will only be deductible where the home is used as a real place of business.

Clothing

Expenditure by an employee on conventional clothing generally is not deductible, but the cost of occupation-specific clothing (eg that worn by a nurse) generally is. The cost of non-conventional uniforms which an employee is compelled to wear is generally deductible, but if the uniform is not compulsory, a deduction is denied unless the design of the uniform is properly registered. Expenditure on items of protective clothing such as aprons, hard hats and steel capped boots is also deductible. The receipt of an allowance from an employer for clothing or uniforms does not necessarily mean that the employee’s expenditure on conventional clothing is deductible. Substantiation Where work expenses of employees, such as meals, tools and trade journals, exceed $300 in total in an income year, the employee must generally satisfy substantiation rules to deduct the expenses. That broadly requires the employee to obtain written evidence of the expense from the supplier and keep it for five years. The degree of substantiation required in respect of car expenses of employees and selfemployed persons varies according to the person’s chosen method of claiming deductions. The $300 substantiation-free threshold is not available for car expenses. Commissioner’s guidelines for particular occupations The Commissioner has issued rulings and guidelines about deductions for people in particular occupations, such as employee cleaners, hospitality industry employees, police officers, teachers, nurses, airline industry employees, real estate industry employees and employee lawyers (see www.ato.gov.au/Individuals/Income-and-deductions/Occupation-and-industry-specific-guides/). Superannuation contributions Employees and self-employed persons may be entitled to tax concessions for contributions to a superannuation fund or RSA. The tax treatment of superannuation contributions is covered from ¶4-200 to ¶4-245.

¶1-325 Deductions for investors and landlords A person who derives investment income, such as rents, dividends or interest, can deduct expenditure incurred in connection with the derivation of that income. Deductions include interest on money borrowed to acquire the investment, ongoing expenses of deriving the income and, in certain circumstances, investment losses. Interest Interest on money borrowed to acquire, say, a rental property, shares in a company or units in a property trust, is generally fully deductible if it is reasonable to expect that rents, dividends or assessable trust distributions will be derived. In determining the purpose to which borrowed funds are put, eg to acquire a rental property, the ATO traces the flow of borrowed funds to establish their usage. The security used for such a borrowing has little relevance in determining the deductibility of interest. Interest can be fully deductible in an income year even though it exceeds the investment income of that year (negative gearing). But if, at the outset, the investment is not expected to turn positive over its full term, the interest deduction in each income year is likely to be at least partly disallowed. Additional interest payable under linked and split loan facilities is not deductible. Interest referable to the capital protection component of limited recourse loans entered into on or after 16 April 2003 is also not deductible. Ongoing expenses Deductible ongoing expenses in deriving investment income include: • expenses of collecting the income, bookkeeping expenses and audit fees • certain fees paid to an investment adviser (see below) • costs of travelling interstate to consult a broker • the cost of financial magazines

• bank charges • borrowing expenses (spread over the shorter of the loan period and five years), and mortgage discharge expenses, including legal expenses connected with the borrowing or discharge • repairs, rates and land tax, insurance, advertising and the legal costs of recovering arrears of rent • expenses connected with the preparation and registration of leases • depreciation of furniture and fittings (although from 1 July 2017 this is limited to the cost of actual outlays incurred by the taxpayer and excludes outlays by a previous owner) • the cost of replacing small items such as crockery and linen. Travel expenses related to inspecting, maintaining or collecting rent for a residential property are not deductible (ITAA97 s 26-31; Law Companion Ruling LCR 2018/7). Repairs versus improvements While the costs of repairs to income-producing property are deductions, the costs of improvements are not. A repair involves the replacement or renewal of a worn-out part so as to restore, but not significantly improve, the functional efficiency of a thing without changing its character. Example Fencing around David’s rental property has been damaged by termites. David replaces the damaged wood panes. Replacing the damaged panes of the fence would be repairs and tax deductible. At the same time David replaces the wood pergola in the backyard with an electric vergola. The replacement of the former wood pergola with the upgraded electric vergola is an improvement to the property.

The cost of initial repairs to remedy defects in an asset at the time of acquisition is also not deductible but is included in the cost base of the asset for CGT purposes or its cost for depreciation purposes. Partial deduction A landlord’s deductions may be reduced where only part of the property is rented or where the property is let or available for let for only part of the year. Where only part of the property is let, deductions are normally allowed according to the proportion of the floor area that is rented. Where a holiday house, say, is let for only part of the income year, deductions are normally allowed according to the proportion of the year for which the house was let, including periods during which bona fide efforts were made to obtain tenants. Financial advice fees The ability to claim a deduction for a fee paid to a financial adviser depends upon the services which are provided in relation to the fee. A taxpayer will not be entitled to deduction for a fee paid to a financial adviser for developing or drawing up an initial investment plan. Such a fee is not deductible as it is considered to be both of a capital nature and a preliminary expense incurred for the purpose of deriving assessable income, as opposed to being a fee incurred in the course of gaining or producing assessable income. An on-going management fee or retainer paid to a financial adviser in relation to the servicing of the income producing investments will be deductible. To the extent that the management fee relates to investments which are not held for the purpose of producing assessable income, a deduction will not be available. Accordingly, where the taxpayer holds a mix of investments held for both income and nonincome producing assets, only a portion of the fee will be deductible. Fees which are paid to a financial adviser for advice regarding the change in mix of the investments held are generally considered to relate to the general management of investments. Such fees will be deductible unless the advice constitutes the drawing up of an investment plan.

Where a taxpayer has investments and pays a financial adviser for drawing up a new investment plan, the fee is considered to be of a capital nature and not deductible. The fee may be included in the cost base of assets acquired. For further explanation see Taxation Determination TD 95/60. Note that if a deduction is claimed for expenditure on financial advice and the taxpayer subsequently receives compensation because the advice is found to be inappropriate (or simply not given), the amount received as a refund or reimbursement will constitute assessable income in the year in which it is received (see ATO website for further information). Losses on investments Losses on investments such as shares and securities are deductible only if the taxpayer is carrying on a business of investing for profit or of trading in investments. Whether a person is carrying on such a business depends on all the facts. Some relevant factors are the frequency, volume and scale of transactions and whether they are carried out in a business-like way.

¶1-330 Depreciating assets The income tax law allows deductions for the decline in value of depreciating assets to the extent the asset is used to produce assessable income or is installed ready for use for that purpose. The deduction is available to an entity that “held” the asset at any time during the income year. This is generally the owner, but another entity may be taken to hold the asset and be entitled to depreciation deductions, for example: • a lessor, eg a finance company, of a depreciating asset that is attached as fixtures to another entity’s land, where the lessor has the right to recover the asset • a lessee of land who affixes a depreciating asset to the land and has a right to remove the asset — while the right to remove the asset exists • a lessee of land who makes an improvement (whether a fixture or not) to the land (eg an in-ground watering system) that the lessee is not entitled to remove — while the lease exists • a hirer under a hire purchase agreement. A depreciating asset is an asset that has a limited effective life and is reasonably expected to decline in value over the time it is used. Land and items of trading stock are not depreciating assets. Most intangible assets are also excluded, but some are specifically included, eg items of intellectual property and inhouse software. With effect from 1 July 2017 the deduction for depreciation on an asset used in relation to a residential rental property is limited to new assets and not previously used assets. In this manner, a deduction for depreciation on second hand assets and assets acquired on the purchase of the property from the former owner will is not available. The formulae for calculating the decline in value of a depreciating asset for an income year are: Prime cost method Cost  effective life 

×

days held  365 

For assets held before 10 May 2006

base value  effective life 

×

days held  365 

×

150%

For assets acquired after 10 May 2006

base value  effective life 

×

days held  365 

×

200%

Diminishing value method

Taxpayers can make their own estimate of the effective life of an asset or rely on the Commissioner’s determination. This choice, and the choice of method, must be made for the year in which the asset is first

used by the taxpayer for any purpose or is installed ready for use. The method chosen for a particular asset applies to that asset for all income years. The base value of a depreciating asset for a year is generally its opening adjustable value (ie broadly its cost less its decline in value up to the start of the year).There is an immediate write-off for depreciating assets costing $300 or less and used predominantly in deriving non-business income. Depreciating assets costing less than, or written down to less than, $1,000 each, can be pooled and a single deduction claimed for the decline in value of the pool for the year. There are special depreciation rules available to small business entities which are detailed in ¶1-283. Instant asset write-off The instant asset write-off available for small business entities is expanded to be available to other businesses for assets that are installed ready for use in the period from 7.30 pm on 2 April 2019 to 31 December 2020. The availability for the instant asset write-off is available for depreciating assets that are purchased during the period from 2 April 2019 and first used, or installed ready for use, in accordance with the following dates and thresholds: Eligible businesses with aggregated turnover up to

Cost threshold Date range for when asset first used or installed ready for use

Less than $500m

12 March 2020 to 31 December 2020

$150,000

Less than $50m

7.30 pm (AEDT) on 2 April 2019 to 11 March 2020

$30,000

Note that the instant asset write-off for the acquisition of motor vehicles is limited to the car cost limit for depreciation, being $57,581 in 2019/20 and $59,136 in 2020/21. Accelerated depreciation Businesses with aggregated turnover less than $500m are entitled to special accelerated depreciation for new depreciating assets acquired and first used, or installed ready for use, in the period from 12 March 2020 to 30 June 2021 with a cost less than $150,000. The accelerated depreciation provides for a deduction of 50% of the cost in the year it is first used, or installed ready for use with the usual depreciation applying for all subsequent years. The accelerated depreciation is only available to the extent that the instant asset write-off is not available and is subject to the luxury car limit. Balancing adjustment When a depreciating asset is disposed of, there is usually a balancing adjustment. A deduction is allowed if the sale price is less than the asset’s adjustable value, and any excess of sale price over adjustable value is assessable. The balancing adjustment is reduced to the extent that the asset was used for nontaxable purposes. Example Frank sold a piece of equipment he used for income-producing purposes for $30,000. It cost $70,000 new and had been depreciated down to $20,000. The balancing adjustment of $10,000 is included in assessable income.

Balancing adjustments may be rolled over in certain circumstances, eg when an asset is transferred as a result of a marriage breakdown. The transferee then becomes entitled to depreciation deductions on the same basis as applied to the transferor, and a balancing adjustment is not calculated until the transferee ultimately disposes of the asset.

¶1-335 Capital works expenditure Deductions are available for capital works expenditure on constructing buildings, such as factories, shops

and home units, and on structural improvements. The capital works must be used in a deductible way during the income year and, for capital works started before 1 July 1997, must have been intended for use for a specified purpose at the time of completion. What constitutes being used in a deductible way varies according to when construction of the capital works commenced. The owner of capital works is generally entitled to an annual deduction of between 2.5% and 4% of the capital expenditure, even if the owner did not incur the original expenditure. Unlike depreciating assets, there is no specific balancing charge on the disposal of a building for which the capital works deduction was available. However, any deduction claimed for capital works on a building acquired by a taxpayer after 13 May 1997 or for improvements made after 30 June 1997 will reduce the cost base of the building for CGT purposes (¶2-200).

¶1-340 Other capital allowances Many other kinds of capital expenditure can also be written off as deductions. The write-off can be either immediate or over a period of years, depending on the kind of expenditure. For example, taxpayers engaged in mining and quarrying operations are entitled to deductions for exploration or prospecting expenditure and for expenditure on rehabilitating former mine sites. Other examples are the deductions for pooled project expenditure (infrastructure expenditure and mining capital and transport expenditure) and expenditure on environmental protection activities. The deduction or offset available for expenditure on research and development is discussed below. For assets acquired after 13 May 1997, deductible capital expenditure is generally excluded from the cost base of the asset for CGT purposes (¶2-200). Research and development A research and development (R&D) tax incentive applies. The incentive currently available is as follows: • a 43.5% refundable tax offset for eligible entities with an aggregated group turnover of $20m or less • a 38.5% non-refundable tax offset for all other eligible entities. Unused non-refundable tax offsets may be able to be carried forward to future years. A limit of $100m applies on the amount of R&D expenditure that a company can claim as an offset at the accelerated rates under the incentive. If a company exceeds this amount, the offset claimable on that excess expenditure is reduced to the relevant company tax rate. Eligible entities are essentially companies incorporated in Australia, foreign incorporated companies that are Australian residents and foreign incorporated non-resident companies that carry on business through a permanent establishment in Australia and that are resident in a country that Australia has a double tax agreement with. Partnerships between such entities are also eligible. However, corporate limited partnerships and exempt entities are not eligible. The refundable tax credit will not be subject to an expenditure cap and will be available to small companies in a tax loss with no limit on the level of R&D expenditure they undertake. The definition of eligible R&D activities is categorised as either “core” or “supporting” R&D activities. Core R&D activities are experimental activities: • whose outcome cannot be known in advance on the basis of current knowledge but can only be determined by applying a systematic progression of work that is based on principles of established science and proceeds from hypothesis to experiment, observation and evaluation, and leads to logical conclusions, and • that are conducted for the purpose of generating new knowledge (including new knowledge in the form of new or improved materials, products, devices, processes or services). Certain specified activities are excluded. Supporting R&D activities are activities directly related to core R&D activities.

¶1-345 Deductible gifts and donations Deductions are allowable for any non-testamentary gift of $2 or more in money or property (eg shares) made to certain nominated funds, institutions and other bodies in Australia. The deduction is available to any person, including individuals, companies and partnerships, and is available to both residents and non-residents. If the gift is of property, it must have been purchased within the previous 12 months, unless the property is valued by the Commissioner at more than $5,000 or is a work of art, a national heritage property or trading stock. Recipients of deductible gifts can either be in the general categories listed in the income tax law or be identified by name in the law. The general categories include: • public or non-profit hospitals • public benevolent institutions • public universities • registered environmental and cultural organisations • approved overseas aid funds. Deductions are only available for gifts made to political parties and independent politicians up to $1,500 where the gift is made by an individual other than in the course of carrying on a business. A deduction can be claimed where a taxpayer enters into a perpetual conservation covenant over the taxpayer’s land with an authorised body for no consideration. The deduction is equal to the decrease in the market value of the land that is attributable to the covenant. Gifts are generally not deductible unless the recipient is registered with the ACNC Commissioner or specifically listed by name in the law. To be registered, the recipient requires an ABN (¶1-120). Gifts of works of art that qualify under the Cultural Gifts Program are exempt from CGT. Also, deductions for gifts of property to certain environmental, cultural and heritage organisations may be spread over five income years. A similar spreading is available for deductions for gifts of property valued by the Commissioner at over $5,000 and for deductions in respect of grants of conservation covenants. A deduction is also available for contributions to a deductible gift recipient where a minor benefit is received in return. An individual can claim a deduction where the value of the contribution is more than $150 and the minor benefit received in return is not more than the lesser of $150 or 10% of the value of the contribution. This deduction would apply where, for example, a person pays to attend a charity ball.

TAX OFFSETS ¶1-350 What are tax offsets? Tax offsets, most of which are rebates, directly reduce the tax payable by taxpayers on their taxable income. Deductions, on the other hand, reduce taxable income and therefore reduce tax payable by a smaller amount. Some offsets are discussed elsewhere in this chapter, eg the rebates for assessable life assurance reversionary bonuses (¶1-275), ETPs (¶1-285) and certain payments in lieu of unused annual leave and unused long service leave (¶1-265) and the franking offset on franked dividends paid by resident companies to resident individual shareholders (¶1-400, ¶1-405). Other tax offsets are discussed in other chapters, eg the rebates for superannuation contributions. Most tax offsets apply only to individual taxpayers. Exceptions to this include the foreign income tax offset, the franking offset, the R&D incentive and the tax offset for an investment in an early stage innovation company. The sum of a taxpayer’s tax offsets for an income year generally cannot exceed the tax otherwise payable for the income year (ie any excess is not refundable and cannot be carried forward to later income years) and tax offsets cannot be set off against the Medicare levy (¶1-075) or any other tax liability. For example, there is no ability to obtain a refund of or carry forward any excess foreign income tax offset. However, any excess private health insurance tax offset (¶1-355) or franking offset for individuals is refundable. Any

excess tax offsets arising from an investment in an early stage innovation company can be carried forward to later income years.

¶1-355 Concessional rebates and offsets Individuals may be entitled to a range of so-called concessional rebates and offsets, such as the low income rebate, the low income aged persons rebate, the medical expenses rebate, the private health insurance tax offset and the dependent (invalid and carer) tax offset (¶20-040). Small business income tax offset Individuals deriving income from an unincorporated small business entity with aggregated annual turnover of less than $5m are entitled to the “small business tax offset” which effectively provides a discount of 13% of the income tax payable in 2020/21 on that business income subject to a maximum cap of $1,000 per year. See ¶1-283 for details of the offset. Low income tax offset The LITO is available to persons whose taxable income is less than $66,667 (see ¶1-055) Low and medium income tax offset The low and medium income tax offset (LMITO) is available to persons whose taxable income is less than $126,000 (see ¶1-055). The LMITO is not available for minors with unearned income and can be applied in conjunction with the LITO. Senior Australians and pensioners tax offset The senior Australians and pensioners tax offset (“SAPTO”) is available to persons of Age Pension age (eg self funded retirees) and recipients of certain pensions, allowances and benefits under the Social Security Act 1991 and the Veterans’ Entitlements Act 1986, which are known as “rebatable benefits”. The amount of the offset available depends upon the person’s rebate income (being the sum of taxable income, reportable superannuation contributions, total net investment loss and adjusted fringe benefits). A married person with unused offset can transfer the unused amount to a spouse who has a tax liability. The LITO and LMITO (see ¶1-055) may also be available where SAPTO does not eliminate tax altogether. For more details on SAPTO, see ¶20-043. Taxpayers entitled to an amount of SAPTO are eligible for an increased income threshold at which they are exempt from paying the Medicare levy or pay a reduced levy. Private health insurance tax offset Individuals are entitled to a tax offset for the cost of the premiums on a private health insurance policy which provides hospital or ancillary cover, or both. The private health insurance tax offset is means tested and applies as follows: INCOME THRESHOLDS Singles

$0–$90,000

$90,001–$105,000

$105,001–$140,000

$140,001 and above

Families*

$0–$180,000

$180,001–$210,000

$210,001–$280,000

$280,001 and above

Maximum Rate#

Tier 1

Tier 2

Tier 3

Aged under 65

25.059%

16.706%

8.352%

Nil

Aged 65–69

29.236%

20.883%

12.529%

Nil

Aged 70 or over

33.413%

25.059%

16.706%

Nil

* Families threshold includes couples and single parents and is increased by $1,500 for each dependent child after the first. # These rates apply for premiums paid after 1 April 2020. The rates will decrease by in accordance with the Rebate Adjustment Factor for premiums paid after 1 April 2021.

If the offset exceeds the tax otherwise payable, the excess is refundable. A person can choose to have premiums reduced instead of claiming the tax offset. Offset for investments in an early stage innovation company (ESIC) Investors are entitled to a non-refundable carry forward offset for qualifying investments in an early stage innovation company (“ESIC”) of 20% of the amount paid for a fresh issue of shares. As flow through entities, trusts and partnerships are not entitled to the offset in their own right. However, members of the trust or partnership can obtain the benefit of the investments made by the entity. The conditions to be an ESIC are detailed in s 360-40 of ITAA97. In general terms, an Australianincorporated company will qualify as an ESIC if it is at an early stage of its development (generally incorporated within three years) and it is developing new or significantly improved innovations with the purpose of commercialisation to generate an economic return. Further conditions require that the company is not listed on the ASX and in the previous income year to investment the company must not have derived assessable income of more than $200,000 or incurred expenses of more than $1m. The offset that may be claimed in an income year is capped at $200,000 (ie investments up to $1m). However, a total investment limit of $50,000 a year applies to retail (non-sophisticated) investors. Such retail investors receive no offset if this limit is exceeded. To be eligible for the offset, an investment cannot exceed 30% of the interests in the relevant ESIC. Investments entitled to the tax offset are exempt from capital gains tax for the first 10 years of the investment (excluding capital gains made in the first 12 months of ownership). Film concessions There are three refundable tax offsets which are available for company taxpayers investing in the Australian screen media: • the producer offset — for Australian expenditure in making Australian films • the location offset — for Australian production expenditure • the PDV offset — for post, digital and visual effects production in Australia. These refundable offsets are only available for company taxpayers.

COMPANIES ¶1-400 Method of taxing company income Companies are taxed as separate legal entities and, like individuals, pay tax on their taxable income (¶1050). Unlike individuals, tax is paid at a flat rate on the whole of a company’s taxable income. The general tax rate for companies is 30%. A company that is a base rate entity is entitled to a lower corporate tax rate of 26% for 2020/21. An entity is a base rate entity if no more than 80% of its assessable income is base rate entity passive income and it has an aggregated turnover below $50m. The tax rate for base rate entities will be further reduced to 25% for the 2021/22 and later income years. Base rate entity passive income includes: • dividends other than non-portfolio dividends • franking credits on such dividends • non-share dividends

• interest income (some exceptions apply) • royalties and rent • gains on qualifying securities • net capital gains • income from trusts or partnerships, to the extent it is referable (either directly or indirectly) to an amount that is otherwise base rate entity passive income. Certain limited partnerships and public trading trusts are taxed as if they are companies. Dividends paid by a company are included in the assessable income of a resident shareholder and taxed at marginal rates but the imputation system (¶1-405) enables a shareholder to receive franking credits for the tax paid by the company on the income distributed. The tax treatment of dividends in the hands of shareholders, including non-resident shareholders, is discussed at ¶1-150 and ¶1-270. Companies are generally required to appoint a public officer to be answerable for doing the things required of the company for tax purposes. In addition, directors and other officers of a company can be liable for the company’s default in certain circumstances. Payment arrangements for company tax are outlined at ¶1-105. Debt and equity The law contains rules to distinguish between equity in a company and debt. The distinction is based on the economic substance of the relevant arrangement under which the interest in the company arises. A debt interest arises where there is an effective obligation on the company to return an amount at least equal to the issue price. Equity includes shares, interests that are convertible into shares and interests that provide returns that are contingent on economic performance — but if an interest is a debt interest it is not treated as equity. A return paid on a debt interest may be deductible. A return on a debt interest (including a dividend on a share that is defined as a debt interest) is deductible to the extent it would be if it were interest, but the dividend is not frankable under the imputation system. The deduction for a return on a debt interest is limited to the rate of return on an ordinary debt interest (ie where returns are not contingent on economic performance) plus 150 basis points. A return on a non-share equity interest (ie an equity interest that is not solely a share) is not deductible but may be frankable. Note that related party at-call loans of companies whose turnover is less than $20m in a year are treated as debt interests. Losses If a company’s deductions exceed its assessable income and any net exempt income, the resulting tax loss can be a deduction in calculating taxable income in later years. Companies will only be entitled to the deduction where the company satisfies either the continuity of ownership or business continuity test. The latter includes the same business test, as well as the more flexible similar business test, which is available for losses made in income years starting on or after 1 July 2015. A company may choose the amount of prior year losses they want to deduct in an income year. Generally, resident companies in the same wholly owned group cannot transfer losses between each other unless they form part of the same consolidated group (see below). The head company of the consolidated group is then entitled to a deduction for the tax loss. A company is a resident if it is incorporated in Australia or, not being incorporated in Australia, carries on business in Australia and has either its central management and control in Australia or its voting power controlled by shareholders who are Australian residents. Example VS Pty Ltd, a resident company, has taxable income of $20,000 for the year ended 30 June 2021 but has tax losses of $50,000 from several years ago. During the year VS Pty Ltd was taken over, with 100% of its shares now held by new owners. It also changed the nature of its operations significantly. VS Pty Ltd will not be able to utilise any of the losses in the company structure. It cannot satisfy the continuity of ownership or

business continuity test and therefore cannot utilise its own losses.

Companies are not able to “carry back” losses to offset past profits. Excessive remuneration Where a company that is a private company for tax purposes excessively remunerates a past or present shareholder or associate for services rendered, the excess over what is reasonable is not deductible. The excess is assessable to the person as a deemed dividend that is not frankable under the imputation system (¶1-405). A company is a private company for tax purposes if it is not a public company for tax purposes. Examples of companies that are public companies for tax purposes are listed companies, subsidiaries of listed companies and government-controlled companies. Loans by private company A private company may be deemed to have paid a dividend simply by paying or lending an amount to a shareholder or associate, forgiving a debt owed to the company by such a person, providing such a person use of an asset for less than arm’s length consideration or having an unpaid present entitlement owing from a trust. Specified transactions are excluded from the rules, including payments to shareholders in their capacity as employees, the payment of genuine debts owed by the company to the person, loans and payments to other companies and loans pursuant to written agreements that meet the prescribed minimum interest rate and maximum loan term. These deemed dividends are generally not frankable, ie they cannot have franking credits attached. However, the Commissioner can exercise a discretion to allow franking credits to be attached to such a dividend where the dividend arose as a result of honest mistake or inadvertent omission. The discretion will only be exercised if the dividend is taken to be paid to a shareholder of the company, as opposed to an associate of a shareholder. The Board of Taxation released a report on the deemed dividend rules relating to private company loans for their effectiveness and whether they can be simplified. The report has identified that the rules are complex, inflexible and costly to comply with. The rules fail to achieve an appropriate balance between ensuring taxpayers are treated fairly, promoting voluntary compliance and discouraging non-compliance. The rules can also operate as an unreasonable impediment for businesses operating through a trust that wish to fund their growth by reinvesting profits back into the business. The report includes a number of recommendations to ease the compliance burden and lower the cost of working capital for companies. Changes to the rules based on the recommendations were proposed to be implemented from 2020/21 but have deferred until the first year starting after the date of royal assent. Special rules Certain types of entities that are companies for tax purposes receive special tax treatment on all or part of their income. They include life assurance companies, co-operatives, credit unions, friendly societies, trade unions and pooled development funds (these are now being phased out) and early stage venture capital limited partnerships (ESVCLP). Consolidation of entity groups Wholly owned groups of companies, trusts and partnerships can choose to be treated as a single consolidated entity for income tax purposes. The main features of the group consolidation regime are: • the head company of a wholly owned group of entities can make an irrevocable choice to consolidate with its wholly owned Australian subsidiaries for income tax purposes. All of the wholly owned consolidated subsidiaries become subsidiary members of the consolidated group with the head company • a consolidated group is treated as a single entity for tax purposes during the period of consolidation • intra-group transactions are ignored for tax purposes • tax matters other than income tax, such as FBT, are not included within the consolidation regime and they continue to be the responsibility of the individual entities in the group. A withholding obligation of

a subsidiary also falls outside the consolidation regime, as it relates to the income tax payable by a third party.

¶1-405 Imputation system Tax paid by Australian resident companies is “imputed” to resident individual shareholders when they are paid franked dividends. That is, the dividend and a franking credit (an amount equal to the company tax attributable to the dividend as allocated by the company) are both included in the shareholder’s assessable income and taxed at marginal rates, and the shareholder is allowed a tax offset (a “franking tax offset”) equal to the franking credit. Excess franking credits are refundable for certain taxpayers but not for most company types. However, excess franking credits in a company are converted into tax losses for the year. Franking credits received by a trust that has a tax loss or nil net income will generally be lost. The tax treatment of dividends, both franked and unfranked, in the hands of residents and non-residents is discussed at ¶1-270. Like individual shareholders, most superannuation funds and ADFs are entitled to the franking tax offset, as are life assurance companies in respect of franked dividends derived from assets included in their insurance funds. Also, resident companies are entitled to the franking tax offset when they are paid franked dividends. Companies, non-complying superannuation funds and non-complying ADFs cannot receive a refund of excess franking credits on dividends received. A holding period rule requires taxpayers to hold shares at risk for more than 45 days (90 days for preference shares) in order to qualify for franking credits and offsets. The 45-day holding period must occur during the period starting on the day after the taxpayer acquires the shares and ending on the 45th day after the shares become “ex-dividend”. Subject to limited exceptions, discretionary trusts will need to make a family trust election to enable its beneficiaries to receive the benefit of its franking credits. Individuals who do not satisfy the holding period rule may nevertheless be entitled to up to $5,000 of franking rebates in relation to an income year. Entities such as complying superannuation funds, life assurance companies and widely held trusts can elect to be taken to be qualified for franking credits or rebates up to a limit calculated in accordance with a statutory formula. Other anti-avoidance provisions dealing with franking credit trading and dividend streaming schemes are referred to below and at ¶1-605 and ¶1-610. Franking accounts and rules for franking dividends The imputation provisions provide that only frankable distributions can be franked and only where they are made by a franking entity (that satisfies a residency requirement at the time). A distribution will only be franked where the entity allocates franking credits to the distribution. Franking entities basically include companies and similar entities, but not non-fixed or discretionary trusts. An entity can determine the extent (up to 100%) to which it will frank its dividends. The main limitations are: • the maximum franking credit rule, which limits the credits that can be allocated • a benchmark rule, which provides that all frankable distributions within a franking period have to be franked to the same extent. The maximum franking credit that can be allocated to a frankable distribution is equal to the maximum amount of tax that the entity making that distribution could hypothetically have paid on the profits underlying the distribution. To calculate the maximum franking credit, the formula is: Amount of the frankable distribution

×

(corporate tax rate for imputation purposes)  (1 − corporate tax rate for imputation purposes) 

The “corporate tax rate for imputation purposes” is generally the entity’s corporate tax rate for the income

year of payment worked out on the assumption that the company’s aggregated turnover for the income year is equal to its aggregated turnover for the previous income year. Example In 2019/20, Imagine Pty Ltd has an aggregated turnover of $30m. In 2020/21, its aggregated turnover increased to $55m. Therefore, for 2020/21, Imagine Pty Ltd will have: • a corporate tax rate of 30% (having regard to its aggregated turnover of $55m in 2020/21) • a corporate tax rate for imputation purposes of 26% (having regard to its aggregated turnover of $30m in 2019/20). Where Imagine pays a fully franked dividend of $7,000 in 2019/20, the maximum franking credit that can be attached to the frankable distribution is $2,459 worked as follows:

$7,000

×

26%  74% 

= $2,459

In the circumstances, the maximum franking credit will be: • where the company has a corporate tax rate for imputation purposes of 26% — 35.14% of the distribution • in any other case — 42.86% of the distribution.

A private company’s franking period is the same as its income year, ie 12 months. For other companies, the franking period is generally six months. Special rules cause franking debits to arise where a company enters into a dividend streaming arrangement. Dividends are streamed where, broadly, a company directs franked dividends to shareholders who are able to fully use the franking tax offset to offset tax otherwise payable while directing unfranked dividends to shareholders (eg non-residents) who are unable to use the franking tax offset. Other anti-avoidance provisions are mentioned at ¶1-605 and ¶1-610. Franking credits can arise from a number of events, including paying a PAYG instalment and receiving a franked dividend. Franking debits can arise in a variety of circumstances, including an amendment of an assessment that reduces tax payable and the payment of a franked dividend. Franking accounts are expressed in dollars of tax paid, rather than the corresponding amount of after-tax taxable income. Example The aggregated annual turnover of ABC Pty Ltd for 2019/20 was $51m and for 2020/21 is $55m. The corporate tax rate for 2020/21 is 30% giving rise to a tax liability of $300,000 for the year based on $1m profit. When this tax is paid, it will give rise to a credit in the company’s franking account of $300,000. ABC’s corporate tax rate for imputation purposes for 2020/21 is also 30% (based on turnover of $51m in 2019/20). Where ABC pays a $700,000 fully franked dividend in 2020/21, the franking credit attached will be $300,000. If instead ABC only had an aggregated annual turnover of $45m in 2019/20, the corporate tax rate for 2020/21 would still be 30% giving rise to a tax liability of $300,000 for the year. This will give rise to a credit in the franking account of $300,000. However, its corporate tax rate for imputation purposes for 2020/21 is 26%. If ABC pays a fully franked dividend of $700,000 in 2020/21, the franking credit attached to the dividend will be $245,946.

If a company taints its share capital account by transferring amounts from other accounts to it (eg by capitalising profits), a franking debit arises and subsequent distributions from the account are treated as unfrankable and unrebatable dividends. If the company elects to untaint the account, a further franking debit may arise and the company may also be liable to pay untainting tax. Below is an illustration of straightforward movements in a franking account of a company that is subject to both a corporate tax rate and a corporate tax rate for imputation purposes of 26%. Date

Details

Debit $

Credit $

Balance $

1 July 2020

Opening balance

–

–

300,000

28 July 2020

PAYG instalment of $65,000

–

65,000

365,000

30 September 2020

Fully franked dividend of $200,000 received from public company ($200,000 × 30/70)

–

85,714

450,714

28 October 2020

PAYG instalment of $65,000

–

65,000

515,714

28 February 2021

PAYG instalment of $65,000

–

65,000

580,714

22,500

–

558,214

–

65,000

623,214

263,513

–

359,700

–

–

359,700

20 March 2021

Refund on assessment of $22,500

28 April 2021

PAYG instalment of $65,000

22 June 2021

Payment of fully franked dividend of $750,000 ($750,000 × 26/74)

30 June 2021

Closing balance (this will be the opening balance on 1 July 2021)

Removal of tax preferences Taxing shareholders on dividends has the effect of removing any tax preferences the company may have enjoyed. That is, if a company receives exempt or concessionally taxed income, that exemption or concession is effectively lost when the income is distributed to individual shareholders as dividends. Generally, such dividends can only be franked to an extent which reflects the lower tax paid by the company because of the exemption or concession. Tax preferences are lost in many other situations too, eg where depreciation deductions for tax purposes exceed the depreciation charged in the company’s accounts, effectively exempting some profit from tax or the concessional tax rate for corporate small business entities. Partners in partnerships and beneficiaries of trusts, on the other hand, generally do not lose tax preferences when income is distributed.

PARTNERSHIPS ¶1-450 Wide definition of partnership for tax purposes A partnership for tax purposes means an association of persons carrying on business as partners in the general law sense or an association of persons in receipt of income jointly, but not including companies. This extended definition has the effect that, for example, persons receiving rents as joint owners of rental property, whether joint tenants or tenants in common, are partners for tax purposes even though they may not be partners at general law because their association and activities as landlords may not amount to carrying on business. Joint ownership of other income-earning investments, such as shares, may also constitute a partnership for tax purposes. Companies, trustees and minors can all be partners. In the case of jointly owned rental properties and other investments, the ATO does not usually require the lodgment of a partnership tax return. Whether a partnership exists is a question of fact. The intention to act as partners is essential but the conduct of the parties must also support that intention. A partnership agreement is not conclusive evidence of the existence of a partnership, but it is significant, as long as the parties act in accordance with the agreement. The Commissioner has published his views on the factors that tend to support the existence of a business partnership. Despite the existence of a partnership where a partner over 18 years of age does not have real and effective control of the partner’s share of partnership income, further tax may be payable so as to, broadly, bring the rate of tax on that uncontrolled partnership income to 45% for 2020/21, being the top marginal rate. A new partnership comes into existence when a partner in an existing partnership dies or retires or when a new partner is admitted.

¶1-455 Method of taxing partnership net income or loss Partnerships are not taxable on their income (except limited partnerships, which are taxed as companies). Instead, partners are assessed individually on their respective interests in the net income of the

partnership. The net income of a partnership is its assessable income, calculated as if the partnership were a resident taxpayer, less its total deductions. If a partnership exists for tax purposes only, ie the partners are not carrying on a business but are in receipt of income jointly, the partners’ shares of partnership net income are determined by their interests in the income-earning property. Although a partnership is not liable to tax, it is still required to lodge an income tax return. Partners derive their share of the partnership net income when partnership accounts are taken, generally at the end of the income year even if the income distribution does not occur until the next income year. Partnership income retains its character in the hands of the partners. Accordingly, where partnership income includes franked dividends, for example, the dividends and the corresponding franking credits and franking tax offsets are apportioned between the partners according to their shares in the partnership net income or partnership loss (see below). Similarly, foreign source income and related foreign income tax offsets retain their identity upon apportionment between the partners. Individuals are entitled to a discount on the income tax payable, up to a maximum of $1,000, on the business income derived from a partnership that is a small business entity pursuant to the small business income tax offset. The discount is currently 13% in 2020/21 (¶1-283). Partnership loss A partnership loss arises when the deductions exceed the assessable income. However, a partnership loss is not trapped inside the partnership and carried forward as a deduction against future income of the partnership. Rather, the partners are allowed a deduction for their individual interest in the partnership loss. If the partnership is carrying on a business, the non-commercial loss rules must be satisfied before an individual partner can offset their partnership loss against other income. The individual interest of a partner in any exempt income (¶1-260) of a partnership is taken into account in calculating and deducting the partner’s own tax losses. Non-resident partners Non-resident partners are not assessed on any part of an individual interest in partnership net income that is attributable to foreign source income derived during a period when the partner was not a resident. Similar rules apply to non-resident partners’ interests in a partnership loss. Interest on partnership borrowings A business partnership is entitled to a deduction for interest on borrowings used to replace working capital of the partnership, thus allowing partners to withdraw the amount of capital contributed and so reduce the net worth of each partner’s interest in the partnership. A deduction is not allowable to the extent the loan replaces capital represented by internally generated goodwill or an unrealised revaluation of assets. A partnership of joint owners of rental property would not be entitled to a deduction for interest on a loan to replace their equity in the property unless their activities as landlords constituted a business partnership under the general law. Partner’s salaries and payments to associated persons Salaries paid to partners are really distributions of the partnership net income. Partnership salaries are not deductible to the partnership, but rather are a way of distributing the net income of the partnership between the partners by allowing some partners to receive larger amounts for their proportionately larger contribution to the partnership. A partnership is not entitled to a deduction for superannuation contributions made in respect of a partner. If a partnership makes a payment or incurs a liability, eg for salary or interest, to a relative of a partner or to another associated person or entity, a deduction is allowed only to the extent that the amount is reasonable having regard to commercial practice. The disallowed amount is generally not assessable income of the recipient.

¶1-460 Exceptions: direct application of law to partners Some provisions of the income tax law apply directly to the partners and do not affect the calculation of the partnership net income or partnership loss. Examples are the provisions allowing deductions for investment in Australian films and the CGT provisions (see Chapter 2). On disposal of a partnership

asset, no capital gain or loss arises to the partnership under the CGT provisions. The gain or loss is taken into account in working out whether each partner’s assessable income includes a net capital gain.

¶1-465 Assignment of partner’s interest in partnership A partner may be able to assign an interest, or a part of an interest, in a partnership to, for example, a spouse so as to shift to the spouse the liability for income tax on the portion of partnership net income that is attributable to the assigned interest. The assignment is, however, treated as a disposal of the relevant part of the partner’s interest in the partnership for CGT purposes. That, in turn, is treated as a disposal or part disposal of the partner’s interests in each of the partnership assets.

TRUSTS ¶1-500 What is a trust? The income tax law contains special rules for taxing the net income of a trust estate. A trust estate (in this chapter called a trust) is property that is vested in a person (the trustee) and held by the trustee for the benefit of other persons (the beneficiaries) under a fiduciary obligation imposed on the trustee. The trustee must act in accordance with the terms of that obligation. A deceased estate is a trust for tax purposes both before and after administration of the estate is completed. The income of unit trusts is generally taxed under the rules applying to trust income, but some public unit trusts are taxed as companies.

¶1-505 Method of taxing trust income or loss A trust is not liable as a separate taxpayer to pay tax on the income of the trust, but it is still required to lodge tax returns. The rules for taxing trust income are set out below. The government has indicated that it proposes to rewrite the rules regarding the taxation of trusts as a result of the High Court’s decision in FC of T v Bamford & Ors; Bamford & Anor v FC of T 2010 ATC ¶20-170 (Bamford). Trustees are only liable as trustees to pay tax on trust income in the limited circumstances provided for by these rules. Any such liability is in the trustee’s representative capacity rather than in a personal capacity. A trust can incur a loss for an income year. If it does, the loss is carried forward and may be allowable as a deduction in a later year (¶1-525). Calculation of net income of trust The tax base for trusts is the net income of the trust. The net income of a trust is its total assessable income calculated as if the trustee were a resident taxpayer, less all deductions. The question of whether a receipt is income is determined by tax law principles rather than by trust law. For example, a capital gain would be capital under trust law, but may be assessable income for tax purposes. Distributed income retains its character Trust income retains its character in the hands of beneficiaries. Accordingly, where trust income includes franked dividends, for example, the attached franking credits and corresponding franking tax offsets flow through to beneficiaries, or the trustee, in proportion to their share of the net income of the trust that is attributable to the dividends (see below). Where permitted by the trust deed, a beneficiary may be made specifically entitled to franked dividends (¶1-270) and capital gains (¶1-295). The tax law does not provide for streaming of other types of income. Foreign source income retains its identity when it flows through to beneficiaries and a foreign income tax offset is available to the beneficiary for its share of the foreign income tax paid by the trustee. Foreign source income is included in the net income of a trust but whether and how it is taxed to beneficiaries or the trustee depends on the operation of the rules set out below. Net income for tax purposes vs net income in trust law It is possible for the net income of a trust for tax purposes to be different from the net income calculated according to trust law, eg if a receipt is treated as income for tax purposes and capital for trust purposes or if depreciation deductions for tax purposes exceed the depreciation charged in the trust’s accounts. If

the net income for trust purposes exceeds the net income for tax purposes, the excess is generally not assessable. If the net income for tax purposes exceeds the net income for trust purposes, the ATO will generally assess the beneficiaries on the excess in proportion to their share of the distributable income. The case of Bamford also raised the question of whether different types of income (eg dividends, capital gains, foreign income) could effectively be streamed for taxation purposes or whether beneficiaries are simply taxed on their proportionate interest in the net income of the trust. The tax law specifically permits capital gains and franked dividends to be streamed to beneficiaries where permitted by the relevant trust deed. To the extent that such amounts are not streamed in this manner they will be apportioned between the beneficiaries proportionately to their share of the trust income. Rules for taxing net income of trust The taxation of trust income depends upon whether: • a beneficiary is “specifically entitled” to a streamed amount • a beneficiary is presently entitled to the income (¶1-510). The treatment will then vary depending upon whether the beneficiary: – is under a legal disability (¶1-515), and – is a resident, or • no beneficiary is presently entitled to the income (¶1-520). Beneficiary specifically entitled Where permitted by the trust deed a beneficiary may be streamed capital gains and franked distributions of a trust fund. In such a case the beneficiary is considered to be specifically entitled to the relevant amount. Where the beneficiary is specifically entitled to a capital gain the beneficiary will effectively be treated as if it made the capital gain itself. Where the beneficiary is specifically entitled to a franked distribution the beneficiary is assessed on the amount of the franked distribution made by the trust and on the franking credits attached to that distribution. If the beneficiary that is specifically entitled to a share of the income of the trust is either under a legal disability (¶1-515) or is not a resident (¶1-550) at the end of the income year, the trustee may be assessed and liable to pay tax on those amounts. The trustee will also be taxed where it chooses to be assessed on a capital gain of the trust if no amount of trust property referable to the capital gain is paid or applied for the benefit of a beneficiary. Beneficiary presently entitled Where a beneficiary is presently entitled (¶1-510) to a share of the income of the trust (excluding the amounts a beneficiary is specifically entitled to), the beneficiary’s assessable income includes that share of the net income of the trust if the beneficiary is not under a legal disability (¶1-515) and is a resident at the end of the income year. A beneficiary is assessable on a share of trust income in the year in which the trust derives the income even if it is not distributed until the following income year (eg a distribution from a cash management trust). The distribution itself will not be taxed. The assessable share does not include any income that is attributable both to foreign sources and to a period when the beneficiary was not a resident. However, such foreign source income is generally assessable income of the beneficiary on distribution if the beneficiary is a resident at any time during the year of distribution. An exempt entity is treated as being presently entitled to any amount of the trust’s income unless it has been paid or notified of their entitlement within two months of the end of the income year. Such amounts will be assessed to the trustee if the requirements are not met. Where a beneficiary is presently entitled to a share of the income of the trust but is either under a legal disability (¶1-515) or is not a resident (¶1-550) at the end of the income year, the trustee is liable to pay tax on that share of the net income of the trust. The trustee is not assessable on any income that is attributable both to foreign sources and to a period when the beneficiary was not a resident. In the case of

a beneficiary who is not a resident at the end of the income year, the beneficiary is also assessed on the share of trust income on which the trustee has been assessed but is allowed a credit for the tax paid by the trustee and a refund of any excess. Trustees of certain closely held trusts (eg discretionary trusts) with a presently entitled beneficiary that is a trustee of another trust must disclose to the Commissioner the identity of the ultimate beneficiaries of certain net income and tax-preferred amounts of the trust. The purpose is to ensure that the ultimate beneficiaries (eg individuals) pay tax on their share of the income. Failure to disclose will result in tax at the highest marginal rate being imposed on the net income. Ultimate beneficiary statements do not have to be lodged unless the trustee has an ultimate beneficiary non-disclosure tax liability for the year or the Commissioner requests a statement. The closely held trusts measures do not apply to: • complying superannuation funds, complying ADFs and PSTs • deceased estates for five years after the death • fixed unit trusts wholly owned by tax-exempt persons, or • listed unit trusts. Example The GT Trust has received income for the year of $65,000 and incurred deductions of $27,000. The net income of the trust is $38,000. Any beneficiary who is presently entitled to a share of this income and is not under a legal disability will be assessed on that share of the net income.

Individuals are entitled to a discount of 13% on the income tax payable, up to a maximum of $1,000, on the business income received as a beneficiary of a trust that is a small business entity pursuant to the small business income tax offset (¶1-283). No beneficiary presently entitled The balance of the net income of the trust, ie net income to which no beneficiary is either specifically entitled or presently entitled (¶1-520) or accumulating income, is assessed to the trustee, generally at the maximum marginal personal tax rate. If the income has a foreign source, the trustee is assessable only if the trust is a resident trust, ie at any time during the income year either a trustee is a resident or the central management and control of the trust is in Australia. Foreign source income that has accumulated in a non-resident trust without being taxed in the hands of the beneficiary or trustee is generally assessable on distribution to a beneficiary who is a resident at any time during the year of distribution. A non-resident trust is a trust that does not have a resident trustee and its central management and control is outside Australia. Additional tax may be payable in such a case by way of interest. Special rules apply to the income of transferor trusts (¶1-570). Distributions to superannuation funds Distributions by trusts to superannuation funds are taxed at 47%, except where the fund has a fixed entitlement to the income. If the fixed entitlement is acquired under a non-arm’s length arrangement, any distribution in excess of an arm’s length amount is also taxed at 47%. Arm’s length distributions to complying superannuation funds with fixed entitlements are taxed at 15%. Exempt income Exempt income of a trust is also allocated among beneficiaries, who are presently entitled and not under a legal disability, according to their individual interests in the exempt income. A prior year’s trust loss, however, must first be set off against exempt income of the trust of the current year before any exempt income is allocated to beneficiaries. Consolidation of entity groups Wholly owned groups of companies, trusts and partnerships can choose to be treated as a single consolidated entity for income tax purposes. For further details, see ¶1-400.

¶1-510 When is a beneficiary presently entitled? Generally speaking, a beneficiary is presently entitled to trust income if the beneficiary has an indefeasible, absolutely vested, beneficial interest in possession of the income, the income is legally available for distribution and the beneficiary can demand immediate payment. The beneficiaries of a deceased estate, for example, are generally not presently entitled until the residue of the estate can be ascertained with certainty. Taxation Determination TD 2018/9 outlines the Commissioner’s views on the impact an early trustee resolution will have on present entitlement. The Commissioner states that an early trustee resolution is not ordinarily effective to make a beneficiary presently entitled to income of the trust estate at that time, given the uncertainty as to whether any distributable income will exist for the year. However, the Commissioner notes that it may be possible to make an effective early resolution appointing income before the end of the income year where it is clear that the trust has income available for distribution and an irrevocable resolution is made to appoint income to the beneficiary. TD 2018/9 also considers whether a beneficiary of a discretionary trust who borrows money at interest and on-lends it to the trustee of a discretion trust interest-free can deduct the interest under s 8-1. For the interest (or any part of it) to be deductible: • the beneficiary must be presently entitled to the trust income at the time the interest expense is incurred, and • the expense has a nexus with the income to which the beneficiary is presently entitled. Beneficiary deemed presently entitled A beneficiary who is not otherwise presently entitled is deemed to be presently entitled to trust income if: • the beneficiary has a vested and indefeasible interest in the income. If such a beneficiary is an individual, the income is generally assessed to the trustee rather than to the beneficiary, or • the trustee exercises a discretion to pay or apply trust income to or for the benefit of the beneficiary. For income to be applied for the benefit of a beneficiary it must be immediately and irrevocably vested in the person. In a further statutory expansion of the concept of presently entitled, a person with an interest in a nonresident trust is deemed to be a beneficiary presently entitled to a share of the income of the trust, the share being calculated according to special rules.

¶1-515 Beneficiary under a legal disability Beneficiaries are under a legal disability if they cannot give a discharge for money paid to them, eg minors and bankrupts. Where a beneficiary under a legal disability derives income from more than one trust, or from other sources (such as interest or dividends) as well as the trust, the beneficiary is required to lodge a tax return and is assessed on all of the income, including trust income that is assessed to the trustee. The beneficiary is entitled to a credit for the tax paid by the trustee on the beneficiary’s share of trust income, but is not entitled to a refund if the tax paid by the trustee exceeds the tax for which the beneficiary would otherwise be liable. Unearned income of a trust to which a minor is presently entitled can be taxed at the highest marginal tax rate (¶1-070). Example Matthew, who is 15 and therefore under a legal disability, is absolutely entitled to a one-fifth share of the income of the First Trust, although he cannot actually receive it until he is 18. The net income of the First Trust is $30,000, and the trustee is therefore liable to pay tax on Matthew’s share of $6,000. Matthew is also a discretionary beneficiary of the Second Trust. In the relevant year, the trustee of the Second Trust pays $2,000 towards Matthew’s school fees. Matthew is deemed to be presently entitled to the $2,000 and the trustee is liable to pay tax on it. In addition, Matthew earns $3,000 from regular part-time work at the local supermarket. Matthew is assessable on $11,000 ($6,000 + $2,000 + $3,000), but the tax he would otherwise pay is reduced by the aggregate of the tax paid by the trustees.

¶1-520 No beneficiary presently entitled to income of deceased estate Before the administration of a deceased estate (a trust for tax purposes) is complete the income is treated as income to which no beneficiary is presently entitled unless some interim distribution of residue is made, in which case the beneficiaries are treated as presently entitled to the distribution. Amounts received by the trustee which would have been assessable to the deceased had they been received before death are treated as income to which no beneficiary is presently entitled. These amounts include investment income, ETPs (¶1-285) and certain fees for professional services, but payments for unused annual leave and unused long service leave are exempt from tax. Where the trustee of a deceased estate is taxed on income to which no beneficiary is presently entitled, the general individual rates (or similar) are likely to apply for a period of up to three years from death rather than the highest marginal rate (which applies generally to trust income to which no beneficiary is presently entitled).

¶1-525 Restrictions on deductions for trust losses A trust loss is not shared among beneficiaries in the way net income of a trust is or in the way partnership losses are shared among partners. Rather, the loss is carried forward in the trust and may be allowed as a deduction in calculating the net income of the trust in subsequent years. Losses are deductible only if the trust satisfies comprehensive tests which relate to ownership, control and trading in units and which restrict the practice of injecting income into loss trusts as a tax shelter. Only the last of these tests applies to family trusts, and then only in a limited way. Family trusts A family trust that survives an income injection test (see below) is allowed a deduction for a prior year loss if it is a family trust at all times during the income year in which the loss was incurred, the income year in which the loss is to be deducted and all intervening years. A trust is a family trust for the purposes of the trust loss rules if it satisfies a family control test and the trustee has made a family trust election, generally in the trust’s tax return for the income year from which the election is to take effect. The election must specify an individual as the person on whom the family group is based. The family control test is satisfied if the individual and/or other family members control the trust. The law contains a comprehensive list of the relationships that qualify people as family members and sets out, in detail, what constitutes control. Control may be exercised through interposed entities. A family trust or interposed entity may be subject to family trust distribution tax on any distribution made to a person outside the family group, which is widely defined for this purpose. The family trust distribution tax rate is 47% for 2019/20. A family trust may be denied a deduction for a prior year loss where assessable income is injected into the trust under a scheme to take advantage of the deduction and, broadly, to give the trustee or a beneficiary and an outsider benefits under the arrangement. This rule does not, however, prevent members of the family group injecting income into the trust for their benefit.

¶1-530 Tax consequences of a trust vesting A trust vests when interests in the trust property are vested in interest and possession. Most trust deeds will specify a date when interests in the trust will vest and outline the consequences of the vesting date occurring. This is to ensure that the trust does not breach the rule against perpetuities. Taxation Ruling TR 2018/6 sets out the Commissioner’s provisional views on the tax consequences of a trust vesting and the ability to validly amend a trust deed. The Commissioner notes the following: • Prior to a trust vesting it may be possible for the trustee or court to amend the vesting date of the trust. However, once the vesting date has passed it is not possible to amend the vesting date. This is because the interests in the trust property are fixed at law. Behaviour of the trustee and beneficiaries in a way that is consistent with the terms of the trust before vesting will not be sufficient to extend the vesting date (see example 1 of TR 2018/6). Extension of the vesting date is subject to the rule against perpetuities which limits extension to a statutory perpetuity period. • The vesting of the trust itself will not cause the trust to come to an end or a new trust to arise.

However, circumstances may arise where parties to a trust relationship act in a manner that results in creation of a new trust. • Vesting of a trust may result in capital gains tax issues, such as CGT event E5 or E7 occurring. Vesting of a trust in itself will not generally result in CGT event E1 occurring (see ¶2-110). • In the income year when a trust vests different beneficiaries may be presently entitled to the trust income before and after the vesting date. For example, a trustee of a discretionary trust may exercise their discretion to appoint income of the trust to particular beneficiaries. However, after vesting the beneficiaries who are “takers on vesting” will have a fixed entitlement to income of the trust estate and will be assessable on their share of the trust net income. The Commissioner will accept an allocation of trust estate income before and after the vesting date, undertaken on a fair and reasonable basis, having regard to relevant circumstances. Any purported distribution by the trustee after vesting is not consistent with the fixed interests of “takers on vesting” is void. The ATO has established a webpage detailing the meaning of a trust vesting and the consequences associated with vesting.

CROSS-BORDER ISSUES ¶1-550 Resident vs non-resident There are major differences in the way Australian residents and non-residents are taxed under Australian income tax law. Tax consequences of being a resident • A resident is assessable on income derived from all sources, whether in or out of Australia, unless an exempting provision applies. Some examples of exempt income are given at ¶1-260. • A resident is assessable on an accruals basis on certain income attributed to the resident as the income is derived by certain controlled foreign companies or by certain non-resident trusts (transferor trusts) to which the resident transferred property or provided services. • A resident is subject to the Medicare levy and potentially the Medicare levy surcharge (if adequate private health insurance is not held). • A resident individual who is a shareholder in an Australian company is entitled to a franking tax offset in respect of franked dividends paid by the company. • A resident is entitled to an offset for foreign tax paid on income from sources outside Australia. • A resident is entitled to the CGT discount on a capital gain arising from assets held for at least 12 months. Tax consequences of being a temporary resident • Foreign sourced income, other than income derived from foreign employment or services, is not taxable in Australia. • Not liable for capital gains tax unless the relevant asset is taxable Australian property. • Not eligible for the CGT discount for holding an asset for at least 12 months. • Special rules apply to capital gains on shares and rights acquired under employee share schemes. • Interest paid foreign residents is not subject to withholding tax. Tax consequences of being a non-resident

• A non-resident is assessable only on income from Australian sources (¶1-555). • A non-resident’s assessable income does not include dividends, interest or royalties on which final withholding tax is payable (¶1-150) or franked dividends that are exempt from withholding tax. • A non-resident individual is not entitled to concessional rebates/offsets or the tax-free threshold (¶1355). • A non-resident is not liable for the Medicare levy or Medicare levy surcharge. • Partners in partnerships and beneficiaries of trusts are not assessed on income derived from foreign sources while the partner or beneficiary was a non-resident. • Subject to certain transitional rules, a non-resident is not entitled to the CGT discount on asset held for at least 12 months. • A non-resident is subject to non-resident CGT withholding tax of 12.5% (unless varied) on the disposal of certain taxable Australian property. • The main residence exemption is not available to a non-resident with effect from 9 May 2017, subject to grandfathering provisions for properties held as at that date to 30 June 2020. • Special CGT rules apply (see Chapter 2). Who is an Australian resident? Individuals An individual is regarded as an Australian resident for income tax purposes if the person either resides in Australia within the ordinary meaning of the term or satisfies one of three statutory tests set out in the income tax law. Ordinary meaning of reside A person who permanently dwells in Australia would usually be considered to reside in Australia. Because it is possible to reside in more than one country at a time, a person who lives permanently abroad may still be an Australian resident if, for example, the person makes visits to Australia as part of the regular order of the person’s life. Statutory tests for residence The income tax law also treats as Australian residents individuals who: • are domiciled in Australia, unless the person’s permanent place of abode is outside Australia. In the absence of evidence of a permanent place of abode outside Australia, a person who leaves Australia with the intention of returning within two years will normally remain an Australian resident • spend more than half the income year in Australia, unless their usual place of abode is outside Australia and they do not intend to take up residence in Australia, or • are members of a Commonwealth Government superannuation scheme (or are the spouse or child under 16 years of a person who is a contributing member). A person that is a resident in accordance with the tests above who is in Australian on a temporary visa, is not an Australian resident within the Social Security Act 1991 and does not have a spouse of a resident within the Social Security Act 1991 is a temporary resident for tax purposes. Companies A company is a resident if it is incorporated in Australia or, not being incorporated in Australia, carries on business in Australia and has either its central management and control in Australia or its voting power controlled by shareholders who are Australian residents.

Other entities The income tax law also contains definitions of a resident superannuation fund, a resident trust estate and a resident public unit trust for specified purposes of the law. Residency status of common situations The following table lists some common situations showing whether the individual would generally be considered a resident or non-resident (note that exceptions exist and professional advice should be sought). Note that residency status may also be affected by double taxation agreements (see below). Situation

Residency status

– goes overseas temporarily, and – does not set up a permanent home in another country

– may continue to be treated as an Australian resident for tax purposes

– is an overseas student enrolled in a course at an – generally treated as an Australian resident Australian institution that is more than six months (potentially temporary resident) for tax purposes long – is visiting Australia for more than six months and for most of that time works in the one job and lives at the same place

– generally treated as an Australian resident (potentially temporary resident) for tax purposes

– is holidaying in Australia, or – is visiting for less than six months

– will generally not be considered an Australian resident for tax purposes

– migrates to Australia, and – intends to reside in Australia permanently

– generally considered to be Australian resident for tax purposes from the date of arrival – likely to be a temporary resident while on a temporary visa

– leaves Australia permanently

– will generally not be considered an Australian resident for tax purposes, from the date of departure

Double taxation agreements Australia’s double taxation agreements with other countries reserve taxing rights over certain classes of income (eg most pensions, purchased annuities and income from independent professional or personal services) to the country of residence of the person deriving the income. The agreements use the countries’ domestic rules to classify each person as a resident of either Australia or the other country but contain “tie breaker” tests to deal with situations where a person would be a resident of both Australia and the other country. The tests have the effect of deeming the dual resident to be a resident solely of one country or the other. Double taxation agreements are also discussed at ¶1-555.

¶1-555 Source of income Like residence, the source of income is a fundamental determinant of liability for Australian income tax. For example: • non-residents are generally assessable only on income from sources in Australia • there are comprehensive rules for taxing residents on foreign source income (¶1-570), allowing offsets for foreign tax paid (¶1-575) • under double taxation agreements between Australia and other countries, income may be taxed in the country in which the income has its source unless taxing rights over the income are reserved entirely to the country of residence (¶1-550) of the person. A deemed source in one or the other country is

attributed by agreements to some classes of income, otherwise the source is determined under the laws of each country. If the country of residence and the source country both tax the income, the country of residence allows a credit for the tax levied by the source country. Source of particular classes of income Ascertaining the source of income has been described as a practical, hard, matter of fact process to be determined separately in each case. The following is a guide to the source of some classes of income: • The source of a dividend is the place where the company paying the dividend made the profits out of which the dividend is paid. • The source of interest is generally the place where the loan contract was entered into. • The Commissioner considers the source of pensions to be where the pension fund is located but the source of annuities to be where the annuity contract is executed. • The source of income from personal services is generally the place where the services are performed, but where special knowledge or creativity is involved the source is likely to be the place where the contract was made.

¶1-560 Thin capitalisation The “thin capitalisation” rules may disallow a proportion of the interest (and other finance expenses) attributable to debt used to finance the Australian operations of Australian and foreign multinational investors. The rules are designed to prevent such investors allocating a disproportionate amount of debt to their Australian operations in order to exploit the more favourable tax treatment of debt compared to equity. The thin capitalisation rules do not apply where the total of the taxpayer’s annual interest and other debt deductions is $2m or less. Where the thin capitalisation rules apply, debt deductions are reduced to the extent that the debt used to fund an entity’s Australian operations exceeds a specified maximum. If the entity is a foreign-controlled Australian company, trust or partnership or the entity is a foreign entity that operates in Australia, the maximum permissible ratio of debt to equity is 1.5:1. A higher arm’s length limit can be substituted where justified. These limits also apply to an Australian entity with foreign operations, but it may be able to use a higher limit again, based on the level of debt it uses in its worldwide operations. The thin capitalisation rules do not apply to such Australian entities (other than foreign-controlled ones) if at least 90% of their assets are Australian assets. Different debt limits apply to financial entities and authorised deposit-taking institutions (ADIs) such as banks. For an outline of how the tax law determines what is debt and what is equity, and how it treats returns on debt and equity interests, see ¶1-400.

¶1-565 Australians investing overseas An Australian resident with foreign investments can have the following amounts included in assessable income: • income, such as dividends, interest and rent, actually derived by the resident • the resident’s share of certain income derived by non-resident entities or accumulating through certain offshore investments, ie the resident is assessed on an accruals basis (¶1-570) without actually deriving the income. An offset is allowed for foreign tax paid (¶1-575). The thin capitalisation rules may restrict deductions for interest (¶1-560).

¶1-570 Accruals taxation system Australian residents are taxed on a share of the income of certain foreign entities which is not comparably taxed overseas. Taxing the resident on an “accruals” basis as the income is derived by the foreign entity

prevents tax deferral and avoidance. There are two separate groups of accruals taxation rules, being the controlled foreign company (CFC) and transferor trust provisions. Controlled foreign companies The controlled foreign company (CFC) rules include in the assessable income of Australian resident controllers (attributable taxpayers) of a CFC a share of, broadly, the CFC’s income from investments and from transactions with associates (attributable income). The rules do not generally apply, however, if the CFC derives more than 95% of its income from genuine business activities. There are also significant exclusions from the attributable income of a CFC (eg franked dividends). The rules apply differently according to whether the CFC’s country of residence is included in one of two categories listed in the law or is an unlisted country. A resident who has more than a specified control interest (including associates’ interests) in a CFC is an attributable taxpayer in relation to the CFC. The law also contains control tests to determine whether a company is a CFC and tests to determine the percentage of a CFC’s attributable income that is attributable to a particular attributable taxpayer. Where a resident’s assessable income has included an amount of attributable income from a CFC, the subsequent distribution of the income by the CFC to the resident is exempt from tax if the resident can establish that the distributed amount has already been attributed. A resident can maintain an attribution account for this purpose. Transferor trusts The “transferor trust” rules include in the assessable income of a resident (an “attributable taxpayer”) income derived by a non-resident trust to which the resident has transferred property or provided services (attributable income). As a separate rule, income distributed by a non-resident trust to a resident beneficiary may attract additional tax if the income has not been subject to the transferor trust rules or otherwise taxed to the trustee or beneficiary when derived. For the purposes of the rules, the attributable income of a non-resident trust is broadly based on the trust’s net income, reduced in several ways (eg by amounts that, broadly, are assessable in Australia to the trustee or a beneficiary as the income is derived). The whole of the attributable income of the trust can be attributed to each attributable taxpayer, subject to reduction by the Commissioner where there is more than one transferor. In some cases, the amount included in the attributable taxpayer’s assessable income is determined by reference to a deemed rate of return on the property transferred. Whether a resident is an attributable taxpayer depends on, among other things, whether the transfer was to a discretionary trust and whether the transfer was at arm’s length. The rules do not apply where transfers are made to non-resident family trusts. As with CFCs, attributable income of a non-resident trust is not assessable to the resident transferor when the income is distributed.

¶1-575 Foreign income tax offset The foreign income tax offset (FITO) system allows taxpayers to claim a foreign income tax offset where they have paid foreign tax on amounts included in their assessable income (ITAA97 Div 770). Under the FITO system the offset is allowed for the income year in which the foreign tax is paid. There is no quarantining of offsets to particular classes of income. The offset may also extend to foreign tax on certain non-assessable income, ie amounts paid out of income previously attributed from a CFC. It is generally not a requirement that the taxpayer be a resident, though in practice this will normally be the case. Normally, the tax must have been paid by the person claiming the offset, though there are exceptions in certain situations, such as where the tax has been deducted at source, or otherwise paid on the taxpayer’s behalf. Special rules also allow the offset to be claimed where foreign tax is paid by CFCs on attributed income. The rules governing attributed income have been considerably simplified, eg by eliminating the need to trace through attributed tax accounts. The offset may be adjusted where the amount of foreign tax is refunded or inflated. For more details on FITO, see Chapter 21 of the CCH Australian Master Tax Guide (59th ed).

¶1-580 Foreign losses Foreign losses are able to be offset against both Australian-sourced and foreign-sourced income. There is no ability for non-utilised foreign losses to be carried forward.

TAX AVOIDANCE ¶1-600 How the law deals with tax avoidance The income tax law deals with tax avoidance in several ways: • specific anti-avoidance provisions deal with particular tax avoidance practices • the general anti-avoidance provisions of the Income Tax Assessment Act 1936 Pt IVA apply to an arrangement as a last resort only after the application of all other provisions of the law has been considered • Income Tax Assessment Act 1997 Div 815 deals with transfer pricing arrangements to shift profits out of Australia. Further, the general deduction provision of the law, which allows deductions for losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, may disallow a deduction to the extent it is incurred in the pursuit of a tax minimisation objective. There would then be no need for recourse to either the general or a specific anti-avoidance provision.

¶1-605 Specific anti-avoidance provisions Arrangements to which specific anti-avoidance provisions apply include: • dividend streaming and franking credit trading, such as: – the streaming of dividends, or of dividends and other benefits, to provide franking credit benefits – the streaming of capital benefits and dividends – dividend substitution schemes • where excessive wages are paid to relatives • non-arm’s length and other unacceptable transactions relating to R&D expenditure • arrangements to shift value involving interests in companies and trusts • arrangements which take advantage of the tax-exempt status of charitable trusts • where property income is derived by a minor • where a tax-exempt entity is interposed between an Australian resident payer and a non-resident recipient of dividends, interest or royalties • the alienation of personal services income to interposed entities (¶1-265) • the multinational tax avoidance rules that apply to artificial or contrived arrangements to avoid the attribution of business profits to a taxable permanent establishment in Australia of a multinational entity with worldwide turnover of $1 billion or more • where an entity engages in conduct that results in either the promotion of a tax exploitation scheme, or in conduct that results in a scheme that has been promoted on the basis of conformity with a

product ruling, but implemented in a materially different way from that described in the product ruling.

¶1-607 Distribution washing provisions To counteract the practice of “distribution washing” (also known as “dividend washing”), special measures in ITAA97 s 207-157 apply. “Distribution washing” essentially refers to the process whereby shareholders who place a relatively high value on franking credits (such as superannuation funds, income tax exempt not-for-profit entities and other shareholders with low marginal tax rates) sell shares on an ex-dividend basis and purchase shares on a cum-dividend basis (in the period after a share goes ex-dividend). This practice enables the shareholder to receive two sets of dividends and claim two sets of franking credits, although in substance, they only ever held one parcel of shares at any point in time. The shareholders who buy ex-dividend shares and sell cum-dividend shares are those who place a relatively low value on franking credits (such as non-residents). The process results in the transfer of value of franking credits from shareholders who should not be able to use them to those who can. In accordance with the special measures, where a taxpayer receives franked distributions due to distribution washing, the taxpayer will not be entitled to a tax offset or the taxpayer will be required to include the amount of the franking credit in their assessable income. For these purposes, the distribution washing rules will apply to a franked distribution received in respect of a membership interest (the “washed interest”) where: • the washed interest was acquired after the member or a connected entity of the member disposed of a substantially identical membership interest, and • a corresponding distribution was made to the member or a connected entity in respect of the substantially identical interest. However, where a connected entity has disposed of the substantially identical interest, the dividend washing rules will only apply if it would be concluded that either the disposal or the acquisition took place only because at least one of the entities expected or believed that the other transaction had or would occur. The term substantially identical interest is a flexible concept to accommodate a wide variety of financial instruments that currently exist as well as new instruments that may be created in the future. For example, an interest will be substantially identical where it is fungible with, or economically equivalent to, the washed interest. However, the distribution washing measures do not apply to an individual that does not receive more than $5,000 in franking credit offset entitlements in a year. In addition to the distribution washing measures, the Commissioner may also apply the general antiavoidance provisions under ITAA36 Pt IVA (see ¶1-610) to a distribution washing arrangement. The potential application of franking credit trading scheme provisions in ITAA36 s 177EA of Pt IVA are addressed in Taxation Determination TD 2014/10. Despite the exemption from the distribution washing measures, individuals who do not receive more than $5,000 in franking credits in an income year are still potentially subject to the anti-avoidance provisions in ITAA36 s 177EA. The ATO has issued a bulletin about dividend washing arrangements that are intended to provide imputation benefits to Australian taxpayers (including individuals and superannuation funds) who are not the true economic owners of shares (Taxpayer Alert TA 2018/1). The ATO considers that s 177EA could apply to these arrangements

¶1-610 General anti-avoidance provisions: Pt IVA The general anti-avoidance provisions (ITAA36 Pt IVA) authorise the Commissioner to cancel a tax benefit obtained by a taxpayer in connection with a scheme where it would be concluded that a person who entered into the scheme did so for the sole or dominant purpose of enabling the taxpayer (or the

taxpayer and others) to obtain a tax benefit in connection with the scheme. Part IVA has been applied to a variety of schemes, including a scheme to exempt interest from Australian tax by giving the interest a foreign source, and several schemes to split personal exertion income where the income flowed predominantly from personal services rather than from business assets. Virtually any arrangement or course of conduct, whether carried out alone or with others, can be a scheme. Tax benefit Part IVA applies where a taxpayer obtains a tax benefit in connection with a scheme. A tax benefit has been obtained in connection with a scheme if as a result of the scheme: • an amount is not included in the taxpayer’s assessable income where the amount would have, or might reasonably be expected to have, been included • a deduction is allowable to the taxpayer where the deduction would not have, or might reasonably be expected not to have, been allowable • a taxpayer is not liable to pay withholding tax on an amount where that taxpayer would have, or could reasonably be expected to have, been liable to pay the withholding tax • a capital loss for CGT purposes is incurred by a taxpayer where the capital loss would not have, or might reasonably be expected not to have, been incurred • a foreign income tax offset is allowable which would not have, or might reasonably be expected not to have, been allowable • an amount is not included in a taxpayer’s assessable income because of a dividend stripping scheme (a deemed tax benefit) • a disposition of shares or an interest in shares (ie franking credit trading) and the payment of a franked dividend would, but for Pt IVA, give rise to a franking credit in the hands of the taxpayer (this is called a “franking credit benefit”). The “would have” and “might reasonably be expected to have” limbs are alternative bases on which a tax benefit can be demonstrated. Where obtaining a tax benefit depends on the “would have” limb, that conclusion must be based solely on a postulate that comprises all of the events or circumstances that actually happened or existed other than those forming part of the scheme. Where obtaining a tax benefit depends on the “might reasonably be expected to have” limb, that conclusion must be based on a postulate that is a reasonable alternative to the scheme, having particular regard to the substance of the scheme and its effect for the taxpayer, but disregarding any potential tax costs. Sole or dominant purpose The application of Pt IVA starts with the consideration of whether, having regard to matters specified in the law, it can be objectively concluded that a person participated in the scheme for the sole or dominant purpose of securing a particular tax benefit in connection with the scheme. That conclusion may be reached even though the particular course of action bears the character of a rational commercial decision or the purpose was that of the taxpayer’s professional adviser. For franking credit trading schemes the relevant purpose need not be the sole or dominant purpose. There is no purpose test for dividend stripping schemes. Mass-marketed tax schemes Part IVA has been applied by the ATO to mass-marketed tax-effective schemes. In recent years the Commissioner has been taking a tougher stance on tax scheme promoters, more than doubling the number of tax officers involved in its scheme task force and increasing its budget. There has been particular focus in relation to the offshore schemes under the widely publicised Project Wickenby.

¶1-615 Transfer pricing The transfer pricing provisions provide a legislative framework for dealing with arrangements under which

profits are shifted out of Australia, primarily through the mechanism of inter-company and intra-company transfer pricing. Transfer pricing allows an Australian resident to reduce assessable income or increase deductions by, for example, reducing selling prices or inflating purchase prices in non-arm’s length dealings. The transfer pricing provisions are contained in ITAA97 Subdiv 815-B (entities), 815-C (permanent establishments) and 815-D (trusts and partnerships) and align the application of the arm’s length principle in Australia’s domestic law with international transfer pricing standards. The transfer pricing rules apply where an entity would otherwise obtain a tax advantage in Australia from cross-border conditions that are inconsistent with the internationally accepted arm’s length principle. Where this applies, the rules provide that the entity’s Australian tax position is determined as if the arm’s length conditions in fact existed. The arm’s length principle applies: • to relevant dealings between both associated and non-associated entities, and • to attribute an entity’s actual income and expenses between its parts. The purpose of the provisions is that, irrespective of whether the entities are related, the amount brought to tax in Australia from non-arm’s length dealings should reflect the economic contribution made by the Australian operations. The transfer pricing rules are “self-executing” in their operation, rather than relying on a determination by the Commissioner. Entities are required to determine the overall tax position that arises from their arrangements with offshore parties on the basis of independent commercial and financial relations or (in the case of the permanent establishment of an entity, on the basis of arm’s length profits) occurring between the entities or the parts of the entity. However, the provisions have a de minimis rule, pursuant to which no penalty is imposed where the scheme shortfall amount is equal to, or less than, the “reasonably arguable threshold”. The threshold is $10,000 or 1% of income tax payable by the entity for the income year. For trusts and partnerships, the threshold is $20,000 or 2% of the entity’s net income for the year. Where an entity would be liable for an administrative penalty under the transfer pricing rules, it will only be able to obtain a reduction of that penalty on the grounds that it has a reasonably arguable position where the entity keeps records that: • are prepared before the time by which the entity lodges its tax return for the relevant income year • are in English, or readily accessible or convertible into English, and • explain the particular way in which the transfer pricing provision applies (or does not apply), and why the application of the provisions in that way achieves consistency with the relevant OECD guidelines and regulations. The ATO has developed simplified record keeping options for certain eligible businesses to use to minimise some of their record keeping and compliance costs associated with the transfer pricing rules. The ATO has issued various taxation rulings and guidance on the application of the transfer pricing rules including: • Taxation Ruling TR 2014/8 (transfer pricing documentation requirements) • Practice Statement PS LA 2014/2 (administration of transfer pricing penalties) • Practice Statement PS LA 2014/3 (simplifying transfer pricing record keeping) • Draft Practice Statement PS LA 3673 (guidance for transfer pricing documentation), and • Taxation Ruling TR 2014/6 (application of s 815-130, about the relevance of actual commercial or financial relations to arm’s length conditions).

Also see the ATO publication entitled “Simplifying Transfer Pricing Record Keeping” on its website at www.ato.gov.au. Since 1 January 2016, multinational companies with worldwide turnover of $1 billion or more are required to provide country-by-country statements to the Commissioner on an annual basis to assist the Commissioner with carrying out transfer pricing risk assessments. Further a diverted profits tax will apply to large multinational corporations with global annual revenue of $1 billion or more. The diverted profits tax is applied at the rate of 40% on profits that are artificially diverted from Australia.

RULINGS ¶1-650 Role of rulings The Commissioner can make private, public and oral rulings, binding on the Commissioner, on the way in which, in his opinion, a particular income tax law or FBT law applies in relation to an arrangement. Rulings are intended to help reduce taxpayers’ uncertainty about the application of the law in a selfassessment environment where the Commissioner makes assessments (or, in the case of companies, is deemed to make assessments) without a technical examination of the information contained in a taxpayer’s return and is given wide powers to amend assessments in the light of subsequent audits — generally for up to four years after tax became due and payable under the original assessment. For assessments in respect of the 2004/05 and later income years, the period is only two years for most individuals and small business entities (¶1-280). A person can object against an unfavourable private ruling (¶1-665). All private rulings are available on a public database with taxpayer identifiers deleted. Individual taxpayers are able to obtain oral rulings in respect of non-complex non-business matters. The Commissioner also issues other types of guidance including Law Companion Rulings and Practical Compliance Guidelines. Types of public rulings and ATO advice Product rulings Product rulings are binding public rulings on the availability of claimed tax benefits from investment “products”. A product refers to an arrangement in which a number of taxpayers individually enter into substantially the same transactions with a common entity or a group of entities. The product may be described as an investment arrangement, a tax-effective arrangement, a financial arrangement or an insurance arrangement. Product rulings are designed to protect investors, provided the arrangement is carried out in accordance with details provided by the applicant and described in the product ruling. Individual investors do not need to apply for private rulings on the arrangement. Promoters, or the persons involved as principals in the carrying out of the arrangement, may apply for a product ruling. A written application is required and a draft of the proposed product ruling must also be provided in the specified format. Class rulings Class rulings are binding public rulings on the application of tax laws to specified classes of persons (participants) in relation to particular arrangements, such as employee retention bonus schemes, employee share and option plans, bona fide redundancy plans, corporate or industry restructures and scrip-for-scrip rollovers. Class rulings will not be given in relation to investment schemes or similar products — the promoters of such schemes can apply for a product ruling (see above). As with product rulings, the aim of the class rulings system is to provide certainty to participants and eliminate the need for individual applications for private rulings. Taxpayer alerts The ATO issues “Taxpayer alerts” as an early warning to taxpayers of significant new and emerging tax planning issues or arrangements that the ATO has under risk assessment. The alerts, which are not

public rulings, are available on the ATO website ATO assist. Law Administration Practice Statements The ATO issues “Law Administration Practice Statements” that provide direction to ATO staff on the approaches to be taken in performing their duties. They are not used to provide interpretative advice and do not convey extra statutory concessions to taxpayers but outline the approach that should be taken. Law Companion Rulings Law Companion Rulings (“LCR”) express the Commissioner’s view on how recently enacted law applies to taxpayers. They seek to provide insight into the practical implications of new law in ways that may go beyond mere questions of interpretation. Practical Compliance Guidelines Practical Compliance Guidelines (“PCG”) provide broad compliance guidance in respect of significant law administration issues. They may include administrative safe harbour approaches which the Commissioner will administer the law in accordance with provided they are followed in good faith. While a PCG is not generally a public ruling and is not legally binding, they represent guidance material on how the ATO will allocate its compliance resources according to assessments of risk. Scope of rulings Rulings can be made on any matter involved in the application of a relevant tax law provision including the administration and collection of taxes. The ATO can provide rulings on ultimate questions of fact, such as the residency status of a taxpayer and whether a business is being carried on. Private rulings must be applied for, and can apply only to the particular person whose arrangement is the subject of the application, and only in respect of a particular income year, whether the current year or a past or future year. Public rulings are generally initiated by the Commissioner and can apply to classes of persons and in relation to classes of arrangements. Product rulings and class rulings can be applied for.

¶1-660 Rulings binding on Commissioner A ruling is binding on the Commissioner where a taxpayer has relied on the ruling. The Commissioner may apply a relevant provision of the law as if the taxpayer had not relied on the public ruling, if doing so would produce a more favourable result for the taxpayer. A ruling is not binding on the Commissioner if it has been nullified because of subsequent legislative change that causes the law that was ruled on to not apply to the arrangement. Nor is a ruling binding if it has been properly withdrawn by the Commissioner, or if the arrangement implemented is different from the one ruled upon. Example Big Wheels Pty Ltd makes and sells bicycles. It has incurred significant legal costs trying to stop a competitor from using a similar trade name. The company does not know whether these expenses are deductible and so decides to apply to the Commissioner for a private ruling. The Commissioner advises that the expenses would be deductible. Big Wheels Pty Ltd relies on the ruling to claim the deduction. However, when the company is subject to a tax audit three years later, the auditor holds that the expenses were nondeductible. Big Wheels can rely on the private ruling given by the Commissioner as they have relied upon it to claim the deduction. The deduction is allowed, even if the ruling is shown to be incorrect.

¶1-665 Objection and review of rulings A person who is dissatisfied with a private ruling can object against it (¶1-710) within a specified period — generally the four years following the due date for lodgment of the person’s tax return for the income year to which the ruling relates (see also ¶1-705). This period is reduced to two years for most individuals and for small business entities. If dissatisfied with the Commissioner’s objection decision, the person can seek review of the decision by

the Administrative Appeals Tribunal (AAT) or appeal to the Federal Court (¶1-710). A review cannot consider facts other than those identified by the Commissioner as being part of the arrangement that was the subject of the ruling. There is no right of objection against a public ruling or an oral ruling.

RETURNS, ASSESSMENTS AND REVIEW ¶1-700 Tax returns A person must lodge a tax return if required to do so by the Commissioner in the relevant Legislative Instrument made annually. The Legislative Instrument also specifies the date by which returns must be lodged. Individuals, partnerships and trusts are generally required to lodge by 31 October following the end of the income year. The Legislative Instrument for 2019/20 was issued on 8 May 2020. Companies and superannuation funds are expected to lodge their returns for 2019/20 in accordance with the ATO’s lodgment program. Details of this program can be found on the ATO website at www.ato.gov.au. Taxpayers are liable to pay an administrative penalty for late lodgment (¶1-755). Failure to lodge a return is an offence (¶1-760). The Commissioner can grant extensions of time to lodge returns.

¶1-705 Tax assessments The Commissioner makes an assessment of an individual’s taxable income and tax payable on the basis of the information contained in the return without examining the return in detail. This process is known as “self-assessment”. The Commissioner issues a notice of assessment to the individual requiring payment of any balance of tax payable not collected under the PAYG system (¶1-105). The assessment system for companies is known as “full self-assessment”. Here, the Commissioner is deemed to have made an assessment of the taxable income and tax payable specified in the company’s tax return. The Commissioner can make a default assessment if a taxpayer fails to lodge a return or the Commissioner is dissatisfied with a return. Taxable income under the default assessment is the amount upon which, in the Commissioner’s judgment, income tax ought to be levied. Amendment of assessments The Commissioner has the power to amend any assessment by making such alterations or additions as he/she thinks necessary, even though tax has been paid. Where there has been avoidance of tax due to fraud or evasion, the amendment can be made at any time. Otherwise, the amendment must generally be made within four years from the date on which tax became due and payable under the assessment. This period is reduced to two years for most individuals and for small business entities.

¶1-710 Review of assessments and other decisions Objection A taxpayer who is dissatisfied with an assessment can object to the Commissioner against it and, if not satisfied with the Commissioner’s decision on the objection, either apply to the AAT for review of the decision or appeal to the Federal Court against the decision. The procedures for exercising these rights are contained in general provisions in the Taxation Administration Act 1953 which apply not only in relation to income tax assessments but also in many other situations where a person is specifically given the right to object against a decision or determination of the Commissioner. The procedures apply, for example, where: • a person is dissatisfied with a determination on a taxpayer’s claim for foreign income tax offsets • a superannuation fund member is dissatisfied with certain features of an assessment of superannuation contributions surcharge

• a person is dissatisfied with a private ruling. A person’s objection against an assessment must set out the grounds on which the person relies but the objection can generally only challenge the Commissioner’s application of the substantive law and not the process by which the assessment was made. Objection against “self-assessment” An objection can be lodged against an assessment even though the assessment was made under the “self-assessment” system solely in reliance on the information contained in the taxpayer’s return, including, in the case of a company, an assessment that was deemed to have been made on that basis. This can happen where the taxpayer, wishing to avoid the risk of administrative penalty, files the return on the basis of the Commissioner’s view of the law as expressed in a ruling but then seeks to challenge that view. Review of objection decision by AAT or Federal Court A taxpayer who is dissatisfied with the Commissioner’s objection decision may apply to the AAT for a review of the decision or appeal to the Federal Court. In either case, the taxpayer has the burden of proving that the assessment is excessive and is generally limited to the grounds stated in the objection. Costs associated with a review or appeal are generally deductible. AAT hearings are generally held in private and the reasons for the decision do not reveal the taxpayer’s identity. AAT proceedings are generally less formal than a court. The AAT need not apply the laws of evidence, may exercise all of the Commissioner’s powers and discretions, and may confirm, vary or set aside the Commissioner’s objection decision. An appeal to the Federal Court against an objection decision is heard by a single judge. The court cannot interfere with the exercise of a discretion by the Commissioner unless the discretion was not exercised in accordance with law. The court may make such order in relation to an objection decision as it thinks fit, including an order confirming or varying the decision. The Commissioner or the taxpayer can appeal to the Federal Court from a decision of the AAT on a question of law. The Federal Court can make such order as it thinks fit. It could, for example, remit the matter to the AAT to be heard again. The Commissioner or the taxpayer can appeal to the Full Federal Court from a decision of a single judge, whether the decision is on an appeal against an objection decision or on an appeal against an AAT decision. An appeal can be made from an order of the Full Federal Court to the High Court, but only with the special leave of the High Court. The Commissioner must give effect to the decision of the AAT or the order of the Federal Court when that decision or order is final, generally by amending the assessment. A decision or order is final once the time for any further appeal has expired. Judicial review of Commissioner’s decisions If the law does not specifically give a person the right to object against a decision of the Commissioner, the further rights of review by the AAT and appeal to the Federal Court just discussed are not available. Some of these decisions may be reviewable by the Federal Magistrates Court or the Federal Court under the Administrative Decisions (Judicial Review) Act 1977. A breach of natural justice, an improper exercise of power or an error of law, for example, would be grounds for review of a decision. Examples of decisions that could be open to this form of administrative review are a refusal to grant a remission of GIC or an extension of time to pay tax and a refusal to vary PAYG withholding amounts.

PENALTIES ¶1-750 Scheme of income tax penalties Three kinds of penalty may be imposed for failure to comply with the requirements of the income tax law and for other specified behaviour related to the operation of the income tax law: • the general interest charge (GIC) or the shortfall interest charge (SIC)

• administrative penalties imposed by the income tax law • a fine or a term of imprisonment imposed by a court in respect of an offence. If a particular act or omission of a person attracts both a liability for administrative penalty and the institution of a prosecution for an offence, the administrative penalty is not payable. General interest charge (GIC) The GIC is payable if an amount owing to the Commissioner is not paid on time, and in certain other circumstances. Examples are: • late payment of tax due on assessment or amendment • late payment of a PAYG instalment (¶1-105). The GIC is calculated daily on a compounding basis. The rate is adjusted quarterly. The GIC is deductible. Shortfall interest charge (SIC) For assessments relating to the 2004/05 and later years, the shortfall interest charge applies instead of the GIC to the period from which the shortfall arose to the date the tax is due and payable. After that date the GIC applies to both the tax shortfall and any SIC accumulated to that point. The SIC is four percentage points lower than the general interest charge. The SIC is deductible.

¶1-755 Administrative penalties Administrative penalties are imposed for a range of taxation offences, including: • failure to lodge activity statements, returns and other documents on time • making false or misleading statements, or in respect of income tax laws or taking positions in statements that are not reasonably arguable • scheme benefits relating to schemes, and • failure to make a statement required for determining a tax-related liability. Where a taxpayer fails to lodge a return or other document by the due date, the penalty which may be imposed will depend upon the size of the entity as follows: Type of entity

Penalty

Small entity

Base penalty of one penalty unit for each 28-day period or part thereof not lodged, up to a maximum of five penalty units

Medium entity

Double the base penalty

Large entity

Five times the base penalty

Significant global entity

500 times the base penalty

A penalty unit equates to $210. Where the document is necessary for the Commissioner to determine the taxpayer’s tax liability accurately and the Commissioner determines that liability without the assistance of the document, the taxpayer is also liable to a further administrative penalty of 75% of the liability. This behaviour also constitutes an offence. Administrative penalties may also be applied where: • a taxpayer fails to keep or retain records as required, fails to retain or produce a declaration about an agent’s authority to lodge a tax return or fails to give reasonable facilities to a taxation officer

exercising access powers — the penalty in each case is 20 penalty units. The behaviour also constitutes an offence • a taxpayer has a “shortfall amount” (an understatement of tax liability) caused by specified behaviour, such as failing to take reasonable care (for details of the behaviours and the penalty, see the table below). Some shortfall behaviour could also constitute the offence of making a false or misleading statement or omitting something which makes the statement misleading, eg where statements giving rise to a shortfall exhibited intentional disregard of the law or deliberate evasion (see the table below). SIC and GIC will also be payable on the shortfall in tax if it is not paid on time • the Commissioner has applied an anti-avoidance provision, eg if Pt IVA is applied the penalty is 50% of the resulting increase in tax payable (25% if the taxpayer’s position is reasonably arguable). The penalties are double where the entity is a significant global entity. “Shortfall amount” administrative penalties Culpable behaviour

Penalty (% of shortfall)

Intentional disregard of the law (deliberate evasion)

75

Recklessness about correct operation of the law

50

Failure to take reasonable care to comply with the law

25

Treatment of law in statement not reasonably arguable

25

These penalties are doubled for significant global entities. Administrative penalties for shortfalls and for tax avoidance provisions applying can be increased in certain circumstances, eg if the taxpayer takes steps to prevent the Commissioner from discovering the shortfall or the applicability of the tax avoidance provision or was liable to pay the same penalty in an earlier accounting period. Conversely, administrative penalty can be reduced if the taxpayer voluntarily tells the Commissioner about the matter. The Commissioner has the discretion to remit administrative penalty.

¶1-760 Offences against the taxation laws A person is guilty of an offence for failing in specified ways to comply with the requirements of the taxation laws and for various other specified forms of behaviour related to the operation of the taxation laws, such as: • making a false or misleading statement • falsifying records with intent to deceive • structuring investments to ensure that TFN withholding tax is not payable on investments where the person has not quoted a TFN. Some offences, if committed by a natural person, are punishable by a fine and/or imprisonment. Others are punishable only by a fine. The penalties are substantial and are higher for second and subsequent offences, ranging from a fine of 20 penalty units for certain first offences to a fine equal to 100 penalty units and/or two years’ imprisonment for certain second and subsequent offences by an individual (fine of 500 penalty units if committed by a company). In addition, a convicted person may be ordered by the court to pay up to twice or three times the tax sought to be avoided. A penalty unit equates to $210. Fines of up to 120 penalty units and/or two years imprisonment (or 600 penalty units if committed by a company) can be imposed for obstructing ATO officers. Prosecution prevails over penalty tax If particular behaviour attracts both a liability for an administrative penalty and the institution of a

prosecution for an offence, the administrative penalty is not payable. An example is where a person fails to lodge an income tax return. Example Richard has deliberately not included some income in his return. After an ATO audit, he was found to have not included $50,000 for two consecutive years. Administrative penalty is imposed for the first year at the rate of 75% of the tax avoided. Richard will also be liable to pay GIC in relation to the underpaid tax. In relation to the second year, the Commissioner decided to prosecute Richard for recklessly making false and misleading statements. Administrative penalty in respect of the shortfall is therefore not payable for the second year. But note that, if convicted, Richard could be ordered by the court (for a first offence) to pay up to double the amount of tax sought to be avoided.

Company officers An officer of a company, such as a director or secretary, is liable to be prosecuted for a taxation offence committed by the company as if the person had committed the offence, although the Commissioner will usually institute prosecution action against the company rather than the officer.

CAPITAL GAINS TAX The big picture

¶2-000

How CGT works

¶2-050

Step 1: What transactions are covered? CGT events and CGT assets

¶2-100

List of CGT events

¶2-110

Step 2: What is the capital gain or loss? Cost base calculation — the information you need

¶2-200

Cost base modifications and special rules

¶2-205

Capital proceeds rules

¶2-208

Calculating the capital gain or loss

¶2-210

Discount capital gains and discount percentage

¶2-215

Discount percentage for particular taxpayers?

¶2-217

Who makes the capital gain or loss?

¶2-220

Step 3: Exemptions, concessions and special rules Types of exemption/concession/special rules

¶2-250

Exemption for pre-CGT assets

¶2-260

Exempt assets, proceeds and transactions

¶2-270

Foreign residents and temporary residents — exemptions and withholding tax ¶2-280 Small business CGT concessions

¶2-300

Basic conditions and additional basic conditions

¶2-310

Maximum net asset value test

¶2-315

Active assets

¶2-320

Significant individual test

¶2-323

CGT concession stakeholder

¶2-325

15-year asset exemption

¶2-336

50% active asset exemption

¶2-337

Small business retirement exemption

¶2-338

Small business replacement asset rollover

¶2-339

Special rules for personal use assets and collectables

¶2-340

Other exemptions or loss-denying transactions

¶2-343

Earnout arrangements

¶2-345

Separate asset rule

¶2-350

Options

¶2-355

Special rules for trustees and beneficiaries of a trust

¶2-360

Step 4: Rolling over/deferring a capital gain or loss Deferring capital gains and losses

¶2-400

Typical rollover situations

¶2-410

Step 5: Calculating the tax Net capital gains and losses

¶2-500

Overlap with other tax rules and avoidance schemes

¶2-520

Keeping records: asset registers

¶2-530

Summary — checklists CGT planning checklist

¶2-600

Taxpayer alerts

¶2-650

CGT topical checklist

¶2-700

¶2-000 Capital gains tax

The big picture This step-by-step checklist sets out how you work out if there is a capital gains tax (CGT) liability in any particular case. Each step is cross-referenced to the explanations in this chapter. Step 1: What transactions are covered? • The situations and transactions which are covered by the CGT rules are listed at ¶2-100. These are called “CGT events”. • If there is no CGT event involved, the CGT rules do not apply and the matter is dealt with under the ordinary tax rules. • If there is a CGT event involved, the CGT rules apply. Step 2: If the CGT rules apply, what is the capital gain or capital loss? • There will be a capital gain if the proceeds from the event exceed the cost base of the asset (¶2200), as adjusted for inflation where relevant. There will be a capital loss if the reduced cost base of the asset exceeds the proceeds (¶2-210). • If there is neither a capital gain nor a capital loss, there are no CGT consequences. This can happen where the proceeds exceed the reduced cost base, but do not exceed the cost base (¶2-210). • Special rules apply in determining who made the capital gain or loss where partnerships, trusts, bankrupts or liquidated companies are involved (¶2-220). Step 3: Is there an exemption, concession or special rule? • If there is either a capital gain or a capital loss, the following extra factors come into play: – whether the taxpayer is an individual, a trust, a superannuation entity or a life insurance company that is entitled to a CGT discount or cost base indexation option (¶2-215) – whether the taxpayer is a resident or a foreign resident. Generally, foreign residents are only subject to the CGT rules on their taxable Australian property (¶2-280) – whether an exemption or concession applies. For example, exemptions apply to assets

acquired before 20 September 1985 (¶2-260), motor cars, a person’s main residence (¶2270) and certain small business asset disposals (¶2-300) – whether there are any other special rules, eg those relating to personal use assets and collectables (¶2-340), earnout rights (¶2-345) or capital improvements (¶2-350). Step 4: Is the capital gain or loss rolled over? • In certain situations, a capital gain or loss is “rolled over”. In certain other situations, a rollover is optional (¶2-400). • If it is rolled over, the gain or loss is deferred. It is not taken into account until the relevant asset is affected by a later CGT event (eg it is disposed of again). Usually the pre-CGT status of the asset is also preserved (¶2-400). Step 5: Calculating the tax • If there is a capital gain: – is the gain reduced by the CGT discount? This is available only for eligible taxpayers (¶2215) – is the amount otherwise assessable under the ordinary tax rules? If so, the capital gain is reduced or eliminated accordingly to avoid double taxation (¶2-520), or – are there any other capital gains during the income year? These are aggregated with the relevant gain to determine the total capital gain (¶2-500). • If there is a capital loss: – are there any other capital losses during the income year? These are aggregated with the relevant loss to determine the total capital loss (¶2-500). • Do total capital gains for the year exceed total capital losses? – if the total capital gains exceed the total capital losses for the year, there is a net capital gain for the year, which is added to the taxpayer’s other assessable income (¶2-500) – if the total capital losses exceed the total capital gains, there is a net capital loss which can be offset against capital gains realised in subsequent years (¶2-500) – if the total capital gains are equal to the total capital losses, they cancel each other and there are no CGT consequences.

¶2-050 How CGT works A person sells shares or shares are declared worthless by a liquidator . . . An investor sells a rental property . . . A beneficiary inherits an estate . . . A businessperson sues for damages . . . A deposit is forfeited . . . A trust is set up . . . A person sets up a home office . . . A person stops being an Australian resident. All of these are situations where the capital gains tax (CGT) rules may apply. The CGT rules have such a wide scope that they potentially apply to any transaction that involves changes in property or legal rights. They must be kept in mind when planning any financial transaction. Scope of this chapter This chapter explains the main features of the CGT rules, with particular emphasis on those aspects which may affect financial planning.

The CGT rules take up hundreds of pages of legislation. The explanations in this chapter necessarily involve a lot of simplification given the wide scope of the CGT regime. Comprehensive commentary may be found in other Wolters Kluwer services such as the Australian Master Tax Guide, Australian Federal Income Tax Reporter and Capital Gains Tax Planner. The Australian Taxation Office (ATO) also provides a vast range of CGT rulings and determinations and other information on its legal database and website (see www.ato.gov.au/Law; www.ato.gov.au/General/Capital-gains-tax/), including information and guidance on CGT issues under development (see www.ato.gov.au/General/ATO-advice-and-guidance/Advice-under-developmentprogram/Advice-under-development---capital-gains-tax-issues). The Board of Taxation also makes recommendations for changes to the CGT regime that may be of interest to taxpayers in particular circumstances (see www.taxboard.gov.au/publications-andmedia/review-reports/). What are the CGT rules? The CGT rules are part of the income tax law and are currently contained in the Income Tax Assessment Act 1997 (ITAA97). Before they were introduced, the income tax law had mainly been concerned with ordinary income, not capital gains. In the case of an investment property, for example, the rent would have always been caught by ITAA97 because it was ordinary income. But if you sold the property itself for a profit, you would be making a capital gain. Until the introduction of the CGT rules, such a gain would generally not have been caught by ITAA97 unless you were in the business of selling properties. The CGT rules are designed to plug this gap. The situations where the CGT rules apply are called “CGT events”. The most common of these is where you dispose of an asset which you acquired after 19 September 1985. However, not all the transactions that come within the rules are so straightforward. As you can see from the situations referred to at the start of this paragraph, many of them do not even involve a disposal in the ordinary sense. There is also a wide range of exemptions, concessions and special rules that complicate the picture. In addition, capital gains and losses can be deferred (rolled over) in certain circumstances. Although capital gains are now taxed in a similar way to income, there are some important differences. For instance, the capital gains for CGT assets purchased before 21 September 1999 are generally calculated as the amount of the gains made after allowance is made for inflation (ie an indexing option is available so that the asset cost is indexed from the date of its purchase). However, no indexation adjustment is available for assets acquired on or after 21 September 1999 (¶2-210). Also, for individuals and certain other taxpayers (but not companies generally), the capital gains that are included in assessable income may be discounted by a specified percentage, ie the discounted capital gains are not taken into assessable income (¶2-215). Capital losses are treated quite differently. Firstly, no allowance is made for inflation. Secondly, they are not deductible against ordinary income, or against capital gains of previous years. They can only be offset against capital gains of the current or future years (¶2-500).

STEP 1: WHAT TRANSACTIONS ARE COVERED? ¶2-100 CGT events and CGT assets The situations in which the CGT rules apply are called “CGT events”. They cover a very wide range of financial dealings and situations (see ¶2-110). CGT assets Most of the CGT events (but not all) involve some sort of dealing with a “CGT asset”. This term is widely defined (s 108-5(1)). It includes any kind of property or a legal or equitable right that is not property. Common examples of CGT assets are land, buildings, shares, units in a unit trust, options, foreign currency, business goodwill, rights under a contract, debts owed to you, and interests in partnerships. Other examples include farm-out arrangements (MT 2012/1 and 2012/2), rights conferred by a franchise agreement (Inglewood & Districts Community Enterprises Ltd v FC of T 2011 ATC ¶10-202), a right in

respect of know-how (such as a contractual right to require the disclosure or non-disclosure of know-how) or a licence to use know-how. This, of course, is not an exhaustive list. Note that “know-how” is knowledge of how to do something and is not a CGT asset as it is neither a form of property nor a legal or equitable right (Taxation Determination TD 2000/33, Taxation Ruling TR 2019/4: seismic data is not CGT asset). Some CGT assets are also subject to special concessions, eg pre-CGT assets, small business assets and a person’s main residence (¶2-250 onwards). Personal use assets (such as boats) and collectables (such as artwork or jewellery) are CGT assets, but special rules and thresholds apply to them (¶2-340). Sometimes buildings and other capital improvements are treated as assets separate from the land (¶2350). ATO guidelines on the tax treatment of crypto-currencies for personal transactions and in business and in exchange transactions are found in www.ato.gov.au/General/gen/tax-treatment-of-crypto-currencies-inaustralia---specifically-bitcoin/ and Taxation Determinations TD 2014/25 (bitcoin is not a “foreign currency”), TD 2014/26 (bitcoin is a CGT asset, not “money”) and TD 2014/27 (bitcoin is trading stock if it is held for the purpose of sale or exchange in the ordinary course of a business). Ordering rules for CGT events or where events overlap The general rule is the relevant CGT event that applies in a situation is the one that is most specific to the situation (ignoring CGT event D1 and H2). If no CGT event covers the transaction, there will not be a capital gain or loss. However, sometimes a transaction is covered by more than one CGT event, or as some of the CGT events are expressed very broadly (eg the creation of “contractual or other rights” (CGT event D1), or the receipt of capital proceeds from an event which “occurs in relation to a CGT asset” (CGT event H2)), there may be an overlap of CGT events. The “most specific” rule is therefore subject to the following exceptions: (1) if the circumstances which give rise to CGT event J2 constitutes another CGT event, CGT event J2 applies in addition to the other event (2) if CGT event K5 happens because CGT event A1, C2 or E8 has happened, CGT event K5 happens in addition to the other event (3) if CGT events happen for which a capital gain or loss is taken into account in working out a foreign hybrid net capital loss amount, which is itself taken into account to see if CGT event K12 happens, CGT event K12 applies in addition to the other CGT events. If no CGT event (other than CGT events D1 and H2) happens, it is then necessary to consider whether these events may apply as residual events. Basically, CGT event D1 applies where contractual or other rights are created, and CGT event H2 applies where there is a receipt of money or other consideration as a result of an act, transaction or event occurring in relation to a CGT asset. The rule is as follows: • CGT event D1 is considered first, and if it happens, that event applies • if CGT event D1 does not happen, see if CGT event H2 happens. If it does, that event applies (ITAA97 s 102-25(3)). CGT event D1 and CGT event H2 come into play only if no other CGT event happens in a particular transaction. Because CGT events D1 and H2 are excluded from the “most specific” rule, they will not apply even if they are the most specific event in a particular situation. Example Eddy fails to complete a contract for the sale and purchase of land which creates a right in the seller to forfeit the deposit made under the contract. CGT event D1 (creation of rights, etc) is the most specific event. However, because the “most specific” rule does not apply to CGT event D1, Eddy must apply the next most specific event which is CGT event C2 (cancellation, surrender and similar endings), rather than CGT event D1.

CGT events are discussed further at ¶2-110.

¶2-110 List of CGT events This paragraph contains a list of the CGT events and a description of the main CGT events which may be relevant for financial planning, details of when the event occurs and how the capital gain or loss is calculated. The ITAA97 labels each CGT event with a letter (from A to L) which identifies its broad transactional grouping and a sequential number, eg CGT event C1, CGT event C2. Exceptions to a CGT event happening may arise in certain circumstances so that it is important to refer to the CGT event provision in the ITAA97 in each case to ascertain whether there are exceptions available. The most common transaction that will have CGT consequences is CGT event A1, which happens when a person disposes of a CGT asset, eg if you sell or give away an asset. Other common CGT events from which a capital gain or capital loss may arise include when: ☐ an asset you own is lost or destroyed (the destruction may be voluntary or involuntary) ☐ shares you own are cancelled, surrendered or redeemed ☐ a liquidator or administrator declares that shares or financial instruments you own are worthless ☐ you enter into an agreement not to work in a particular industry for a set period of time ☐ a trustee makes a non-assessable payment to you from a managed fund or other unit trusts ☐ a company makes a payment (not a dividend) to you as a shareholder ☐ you receive an amount from a local council for disruption to your business assets by roadworks ☐ you enter into a conservation covenant ☐ you dispose of a depreciating asset that you used for private purposes ☐ you stop being an Australian resident. Australian residents make a capital gain or capital loss if a CGT event happens to any of their assets anywhere in the world. As a general rule, a foreign resident makes a capital gain or capital loss only if a CGT event happens to a CGT asset that is taxable Australian property (¶2-280), but may make a capital gain or capital loss where the CGT event creates contractual or other rights (CGT event D1), or a trust over future property (CGT event E9). Disposal of a CGT asset (CGT event A1) • A CGT asset is disposed of, eg when you sell land. This is the most common type of CGT event. It covers the situation where there is a disposal of a CGT asset, whether because of some act or event or by operation of law. A disposal includes any change of ownership of the asset, such as gifting an asset, forfeiture of property under a state law, or a taxpayer ceasing to hold an asset as trustee of a trust and commencing to hold the asset in its own capacity (ID 2010/72). CGT event A1 also happened when there was a transfer of registration of shares in two public companies by a husband from his name to joint ownership with his wife (Murphy v FC of T [2014] AATA 461), and when the trustee of a family trust entered into a contract to sell its business (Case 7/2014 2014 ATC ¶1-069). There are many situations where there is no disposal (and CGT A1 does not happen), for example there is simply a change of trustee of a trust holding the asset, an asset vests in a trustee in bankruptcy or in a liquidator of a company, a bare trust is created by transferring an asset to a trustee, two or more CGT assets are merged into a single asset (TD 2000/10), or a partnership converts into a limited partnership (ID 2010/210). CGT event A1 occurs at the time of the making of the contract. If there is no contract, the event occurs at the time when the ownership changes (Case 2/2013 2013 ATC ¶1-051: event happened on execution of

Heads of Agreement, rather than a formal contract; Scanlon & Anor v FC of T 2014 ATC ¶10-378: event occurred when two taxpayers countersigned a letter of offer from a purchaser to purchase their business, rather than on the day when the formal share purchase agreement was executed). Example Marco is selling his house and enters into a contract with Jane on 18 July 2019, at which time Jane pays Marco a deposit. The contract is settled on 31 August 2019 when Jane pays the balance of the purchase price to Marco. The time of the disposal of Marco’s house is the date he entered into the contract with Jane, ie 18 July 2019.

A capital gain from CGT event A1 happening is calculated as the capital proceeds less the cost base. A capital loss arises if the reduced cost base is less than the capital proceeds. More complex situations can arise for payments received in connection with particular profit-making schemes or business enterprises where the payments are considered revenue rather than capital in nature (Doyle v FC of T 2020 ATC ¶10-522, [2020] AATA 345 (Federal Court appeal pending: proceeds from sale of undeveloped land, Taxation Ruling TR 2002/14, Practical Compliance Guideline PCG 2019/4: retirement village operators). Disposal of shares under a contract or a scheme of arrangement Taxation Ruling TR 2010/4 deals with the CGT consequences arising from CGT event A1 happening to a disposal of shares under a contract or under a scheme of arrangement under Pt 5.1 of the Corporations Act 2001 where the parties act at arm’s length. The ruling explains when a dividend declared or paid by an Australian resident company (the target company) to a resident shareholder who has disposed of shares in the target company under a contract of sale or scheme of arrangement will constitute capital proceeds from the disposal of the shares. In such cases, the dividend does not constitute part of the cost base of those shares for their purchaser. The ruling also explains the consequences for the vendor shareholder under s 118-20 (see below), where a dividend forms part of the capital proceeds from a disposal of shares. Rights and retail premiums under renounceable rights offers Taxation Ruling TR 2017/4 provides guidelines on the CGT issues and taxation of rights granted, and retail premiums paid, to retail shareholders in connection with renounceable rights offers (to the extent the rights and premiums relate to shares held on capital account). Australian resident eligible shareholders and foreign resident ineligible shareholders covered by this ruling do not need to include anything in their assessable income upon the grant of the entitlement. Any retail premium received is treated as the realisation of a CGT asset. Deferred transfers of title (CGT event B1) • Use and enjoyment of an asset is granted before settlement of a sale, eg where a purchaser of land gets possession before the sale is completed. This event occurs when the use and enjoyment of the asset changes hands. Capital gains and losses are calculated as for disposals. Termination, loss or cancellation of a CGT asset (CGT events C1 to C3) • A CGT asset is lost or destroyed. If compensation is received, the event occurs at that time. Otherwise it occurs when the loss is discovered or the destruction occurred. Capital gains and losses are calculated as for disposals. Example A factory owned by TVM Pty Ltd was destroyed by fire on 1 August 2019. A claim for insurance was made on 2 August, but the insurance company disputed the claim and a final settlement was not made until 12 September 2019. The time at which TVM will be taken to have disposed of the building is 12 September 2019, ie when the compensation was received.

• A CGT asset is cancelled or surrendered. If there is a contract, the event occurs when the contract is entered into, otherwise it occurs when the asset “ends”. Capital gains and losses are calculated as for

disposals. For example, CGT event C2 will apply on the maturity or close-out of a financial contract for differences, or when debts are extinguished (QFL Photographics Pty Ltd v FC of T 2010 ATC ¶10-152; Carberry v FC of T 2011 ATC ¶10-181: capital payment under the Groundwater Structural Adjustment Program; Case 6/2015 2015 ATC ¶1-077: right to be indemnified ending). In Coshott v FC of T 2015 ATC ¶20-508, the Federal Court remitted the case for redetermination as the AAT had failed to discharge its review function in relation to the assessment of the incidental costs incurred by the taxpayer in the second element of the cost base. The taxpayer had accepted there was a CGT event C2 which occurred at the time of execution of the deed of settlement in the negligence and breach of contract claim. • An option to acquire shares, trust units or debentures expires. This event occurs when the option expires. The capital gain is calculated as the proceeds from granting the option less expenditure in granting it. The capital loss is calculated as the expenditure in granting the option less the proceeds. Retail premiums paid to shareholders where share entitlements are not taken up or unavailable Where a company grants rights (entitlements) to its existing shareholders that allow them to subscribe for an allotment of new shares in the company at an amount (the “offer price”), shareholders can choose not to exercise some or all of their entitlements, or are not eligible to receive an entitlement or are not permitted to exercise rights under it (in these respects, these shareholders are “non-participating shareholders”). Taxation Ruling TR 2012/1 provides guidelines on the taxation of retail premiums paid to shareholders in companies in respect of amounts subscribed for shares. Bringing a CGT asset into existence (CGT events D1 to D4) • Contractual or other rights are created, eg you enter into a restrictive covenant or grant an easement. The event occurs when the contract is entered into or the right is created. There will be a capital gain if the payment for the right exceeds the incidental costs of creating it. There will be a capital loss in the reverse situation. (This event is disregarded if it results in another CGT event occurring. It also does not apply when a loan is made or shares or units are allotted.) Whether a particular agreement involves a profit à prendre or a sale of goods will depend on the intentions of the parties determined from the terms of the agreement and other relevant circumstances. CGT event D1 (about the creation of rights) rather than CGT event A1 (about the disposal of an asset) happens if a taxpayer grants an easement, profit à prendre or licence over an asset. Consequently: • no part of the cost base of the asset can be taken into account in working out the amount of any capital gain or capital loss that arises from the grant • any capital gain or capital loss from the grant cannot be disregarded merely because the asset was acquired prior to 20 September 1985 • any capital gain from the grant is not a discount capital gain, and • the ITAA97 Div 118 exemption is not available if the grant relates to a main residence (as CGT event D1 is not one of the events listed in s 118-110(2) that is relevant to that exemption) (TD 2018/15). Example — grant of easement Jane owns a property on 1 January 1985. She granted an easement over the property on 1 January 2019 and received $40,000 and incurred $1,000 in legal expenses in relation to the grant. Jane will have a capital gain of $39,000 in respect of the grant of the easement (capital proceeds $40,000 less incidental costs $1,000). The capital gain is not a discount capital gain. Jane cannot disregard the capital gain even though the property over which the easement was granted was acquired before 20 September 1985 (a pre-CGT asset). Neither can she disregard the capital gain even if the property is her main residence.

• An option is granted. The event occurs at the time of the grant. There will be a capital gain if the payment for the grant exceeds the costs of granting it. There will be a capital loss in the reverse situation. For employees receiving options under an employee share scheme, the tax rules relating to employee share schemes will also need to be considered.

• There is a grant of a right to income from mining. The event occurs when the relevant contract is made or, if there is no contract, when the right is granted. There will be a capital gain if the payment for the grant exceeds the costs of granting it. There will be a capital loss in the reverse situation. • A conservation covenant is entered into. The event occurs when a taxpayer enters into a conservation covenant over land that it owns. There will be a capital gain if the proceeds from the covenant exceed the cost base of the land apportioned to the covenant. There will be a capital loss in the reverse situation. There will be no capital gain or loss if the taxpayer acquired the land before 20 September 1985. If the taxpayer enters into the covenant for no material benefit and is entitled to a deduction, the capital proceeds are the deduction amount. But if there are no capital proceeds and no deduction, CGT event D1 will apply instead of CGT event D4. Trusts (CGT events E1 to E10) • A trust is created over a CGT asset. This is CGT event E1 which occurs when the trust is created (Oswal v FC of T 2013 ATC ¶20-403: family trust appointing assets for the absolute benefit of named beneficiaries; see also “Settlement and resettlement of trust issues” and Taras Nominees Pty Ltd As Trustee For The Burnley Street Trust v FC of T 2015 ATC ¶20-483 (Taras Nominees) below). A capital gain will arise if the proceeds exceed the asset’s cost base, or a capital loss will arise if the reduced cost base exceeds the proceeds. • A CGT asset is transferred to a trust. This is CGT event E2 which occurs when the asset is transferred (Healey v FC of T (No 2) 2012 ATC ¶20-365: beneficiary of a discretionary trust and share transactions concerning the trustee of the trust). There will be a capital gain if the proceeds exceed the asset’s cost base, and a capital loss if the reduced cost base exceeds the proceeds. In the following two circumstances, CGT event E1 or E2 does not occur: • where a person is the sole beneficiary of a trust that is not a unit trust and is absolutely entitled to the asset as against the trustee, or • the trust is created by transferring the asset from another trust and the beneficiaries and terms of both trusts are the same (formerly known as the “trust cloning exception” which ceased to apply to CGT events on or after 1 November 2008). The exception to CGT event E1 was held not to be available for the taxpayers in Kafataris & Anor v DFC of T 2008 ATC ¶20-048 who executed identical trust deeds over their respective interests in a property for the purpose of establishing superannuation funds for themselves. In Taras Nominees 2015 ATC ¶20-483, the Full Federal Court confirmed that CGT event E1 happened when land was transferred to a trustee to hold on trust for a joint venture development as the transferee did not maintain absolute entitlement as against the trustee or have sole beneficial entitlement. CGT event E2 did not happen as the there was no completed trust at the relevant time. Although the disposal of the land also means that CGT event A1 happened, CGT event E1 applied, being more specific to the taxpayer’s situation than CGT event A1 (s 102-25(1)). • A trust is converted to a unit trust. This is CGT event E3 which occurs when the trust is converted. There is a capital gain if the market value of the asset exceeds the cost base, and a capital loss if the reduced cost base exceeds the market value. • A trustee makes a capital payment to a beneficiary for a trust interest. This is CGT event E4 which occurs at the time of payment. There is a capital gain to the beneficiary if the non-assessable part of the payment exceeds the cost base of the trust interest. This event includes the situation where tax-free distributions are made by a trust to beneficiaries (¶2-205). The capital gain is equal to the excess and the cost base and reduced cost base of the unit or interest is reduced to nil. If the non-assessable part is not more than the cost base, there is no capital gain, but the cost base and the reduced cost base are reduced accordingly (see TD 93/170 and TD 93/171). CGT event E4 cannot produce a capital loss, and any capital gain will be disregarded if the taxpayer acquired the unit or interest before 20 September 1985. There are many situations when CGT event E4 does not happen — eg to the extent that the payment is reasonably attributable to an “LIC capital gain” made by a listed investment company, or if the payment involves CGT events A1, C2, E1, E2, E6 or E7 happening in

relation to the trust unit or interest, or in relation to a unit or an interest in an attribution managed investment trust (AMIT) (as CGT event E10 will apply), or where the payment is to a beneficiary of a discretionary trust or a default beneficiary whose interest was not acquired for consideration or by way of assignment: TD 2003/28, or where a trust receives a tax-free capital gain under the early stage innovation company provisions. • A beneficiary becomes absolutely entitled to a trust asset. This is CGT event E5 which occurs when the entitlement arises. There is a capital gain to the trustee if the market value of the asset exceeds its cost base, and a capital gain to the beneficiary if the market value exceeds the cost base of the beneficiary’s capital interest. There is a capital loss to the trustee where the reduced cost base of the asset exceeds the market value, and for the beneficiary where the reduced cost base of the capital interest exceeds the market value. Taxation Ruling TR 2018/6 notes that vesting of a trust may result in “takers on vesting” becoming absolutely entitled to the trust assets and CGT event E5 occurring. • A trustee disposes of a CGT asset to a beneficiary to end the beneficiary’s right to receive income (CGT event E6) or to an interest in capital (CGT event E7). The event occurs at the time of disposal. There is a capital gain to the trustee if the market value of the asset exceeds its cost base, and for the beneficiary if the market value exceeds the cost base of the beneficiary’s right to income/interest in capital. There is a capital loss to the trustee if the reduced cost base of the asset exceeds the market value, and to the beneficiary if the reduced cost base of the beneficiary’s right to income/interest in capital exceeds the market value. Taxation Ruling TR 2018/6 states that upon vesting of a trust CGT event E7 may occur (on actual distribution of CGT assets to beneficiaries), but will not occur if the beneficiaries are already absolutely entitled to the CGT asset against the trustee (see further below). • A beneficiary disposes of an interest in capital. This is CGT event E8 which occurs when the contract is entered into or, if there is no contract, when the beneficiary ceases to own the interest. There is a capital gain if the proceeds exceed an appropriate proportion of the trust’s net assets, and a capital loss in the reverse situation. • You agree to hold future property in trust. This is CGT event E9 which occurs at the time of the agreement. There is a capital gain if the market value of the property exceeds the incidental costs, and a capital loss in the reverse situation. • Annual cost base reduction exceeds cost base of interest in AMIT. This is CGT event E10 which happens to a taxpayer that holds a CGT asset that is a unit or interest in an AMIT, the cost base of that CGT asset is reduced due to tax-deferred distributions (s 104-107B) and the “AMIT cost base net amount” for the income year of the reduction exceeds the asset’s cost. The time of the CGT event is the time of the reduction. The capital gain is equal to the excess. Settlement and resettlement of trust issues The term “settlement” is not defined in ITAA97 and therefore takes its common law meaning. The meaning of settlement was addressed in Taras Nominees 2015 ATC ¶20-483, which held that CGT event E1 arose because a trust was created by settlement as a result of land being transferred by the taxpayer to a trustee to hold on trust for the benefit of others pursuant to a joint venture development. The arrangement was not excluded under s 104-55(5) as the taxpayer was not the sole beneficiary of the trust and/or was not absolutely entitled to the land as against the trustee. In accordance with Kafataris 2015 ATC ¶20-523 (see CGT event E1 above), the term “declaration” takes its ordinary meaning. A trust is created by “declaration” when it is created by the holder of an undivided legal interest in property using words or actions which sufficiently evidence an intention to create a trust over that property. In that case, the transfer of a jointly owned property by a husband and wife to a wholly owned company created a trust over the property by declaration or settlement and therefore gave rise to CGT event E1 (as opposed to CGT event A1). On resettlements, the question of whether a trust has sufficiently changed to the extent that there is no longer sufficient continuity between the trust as originally constituted and the trust in its current form is relevant in a number of taxation contexts. In FC of T v Clark & Anor 2011 ATC ¶20-236, the court examined the circumstances in which it may be concluded that the nature of a trust has so changed that the trust which had originally incurred capital losses is not the same trust for tax purposes as that which has derived gains against which the losses could be recouped.

Although Clark’s case was about whether the changes in a continuing trust were sufficient to treat the trust as a different taxpayer for the purpose of applying a net capital loss, the ATO accepts that the principles in the case have broader application. For example, this may mean that a valid amendment to a trust, not resulting in a termination of the trust, will not of itself result in the happening of CGT event E1. If the terms of a trust are changed or amended pursuant to a valid exercise of a power within its trust deed or with the approval of a relevant court, neither CGT event E1 nor E2 happens. Examples are when amendments are made to add the spouses of children in the general beneficiaries class, expand the fund’s power to invest, or permit the trustee of the trust to stream income. Taxation Ruling TR 2018/6 states that a trust vesting will not of itself ordinarily cause a trust to come to an end and for the property to be settled on the terms of a new trust. Therefore CGT event E1 will not occur only because a trust has vested. However, the actions of the parties to a trust relationship may be such that a new trust is created by declaration or settlement. (See example 4 in TR 2018/6.) The exceptions when CGT events E1 or E2 may happen are if the change or amendment causes the trust to terminate and a new trust to arise for trust law purposes, or the effect of the change or court approved variation is such that it leads to a particular asset being subject to a separate charter of rights and obligations, such as to give rise to the conclusion that that asset has been settled on terms of a different trust (TD 2012/21). Example — settling of trust asset on new trust The class of beneficiaries (objects) of the Rhoner Discretionary Trust consists of a large number of entities. The trustee has a wide range of powers, including the power to declare that particular assets of the trust are to be held exclusively for one of the trust objects to the exclusion of the other objects. In exercise of this power, the trustee amends the deed with the effect that the trustee commences to hold one of several assets forming part of the corpus of the trust (subject to the trustee’s other powers, such as its power of sale) exclusively in trust for Ms Rhone, one of the objects of the trust. While the amendment does not terminate the Rhoner Trust, its effect is to vary the trust obligations in respect of the asset concerned so as to cause the asset to be held on the terms of a new trust for the benefit of Ms Rhone as sole beneficiary. In such a case, CGT event E1 happens.

Other examples of changes/court approved variations include: • the addition of new entities to, and exclusion of existing entities from, class of objects, and • expansion of a power to invest, or the addition of a definition of income and power to stream, and extension of vesting date. Certain types of arrangements referred to as “trust splits” will trigger CGT event E1. A “trust split” (which usually involves a discretionary trust that is part of a family group) refers to an arrangement where the parties to an existing trust functionally split the trust’s operation so that some trust assets are controlled by and held for the benefit of one class of beneficiaries and other trust assets for the benefit of others. Trust split arrangements with the features specified in Taxation Determination TD 2019/14 will result in the creation of a trust by declaration or settlement as the trustee will have new personal obligations and new rights have been annexed to property. This can cause CGT event E1 to happen. Leases (CGT events F1 to F5) • A lessor grants, renews or extends a lease. The event occurs at the start of the lease, renewal or extension. (If there is a lease contract, the event occurs when this was entered into.) There will be a capital gain to the lessor if the lease premium exceeds the expenditure relevant to the transaction. There will be a capital loss if the premium is less than that expenditure. • A lessor grants, renews or extends a long-term lease. The event occurs when the lease is granted, or the renewal or extension starts. There will be a capital gain to the lessor if the premium exceeds the cost base of the leased property. There will be a capital loss if the reduced cost base of the lease exceeds the premium. • A lessor pays the lessee to get the lease changed. The event occurs when the lease term is varied or waived. For the lessor, there will be a capital loss equal to the amount paid. For the lessee, the capital gain is calculated as the capital proceeds less the cost base of the lease. Shares (CGT events G1 and G3)

• A company makes a capital payment for a shareholder’s shares (CGT event G1). This event occurs when the company makes the payment. There is a capital gain to the shareholder where the payment exceeds the cost base of the shares. See also ¶2-205. Example Kellville Pty Ltd, under a share buyback arrangement, makes a payment of $4 per share to obtain Sally’s shares in Kellyville. The cost base of Sally’s shares is $3 per share. The disposal will occur when the company pays Sally and she will make a capital gain of $1 per share in respect of the buyback.

• A liquidator or an insolvency practitioner (eg an administrator) declares that your shares are worthless (CGT event G3). This event occurs at the time of the declaration. The capital loss is equal to the shares’ reduced cost base. There can, of course, be no capital gain. Where shares and other securities in a company are declared to be worthless for CGT purposes, the declaration will cause CGT event G3 to occur and allow shareholders to choose to make a capital loss in respect of their shares. Without such a declaration, shareholders cannot choose to make a capital loss on “worthless” shares while the company continues to exist. Instead, they must create a trust over the shares if they wish to utilise their capital losses and incur any associated costs. The effect of CGT event G3 means that once it happens, the security holders do not have to incur the cost of establishing a trust and they can take account of worthless investments earlier, thus removing a disincentive to invest in shares and securities. Example Hilda purchased shares in Everlasting Insurance Ltd after 20 September 1985. The company commenced winding-up proceedings in July 2019. On 10 October 2019, the liquidator declared that there was no likelihood that shareholders of Everlasting Insurance Ltd would receive any further distribution in the course of winding up the company. CGT event G3 has happened in relation to Hilda’s shares. Hilda can choose to make a capital loss equal to the reduced cost base of her shares in Everlasting Insurance Ltd as at 10 October 2019.

A share buy-back occurs when a company buys back its own shares from a shareholder. These shares are then cancelled as required by the Corporations Act 2001. The buy-back is an “on-market share buyback” if the shares are listed on a stock exchange in Australia or anywhere else, and the buy-back is made in the ordinary course of trading on that stock exchange. A Community Bank company which is listed on the National Stock Exchange of Australia (NSX) may undertake an on-market buy back. All other share buy-backs, whether conducted by an NSX-listed Community Bank company (but not in the ordinary course of trading on the NSX), or an unlisted Community Bank company, are “off-market share buy-backs”. The ATO guidelines on conducting off-market share buy-backs and returns of capital by Community Bank companies and the tax consequences for shareholders are available from its legal website (www.ATO.gov.au/law). Special receipts — forfeiting a deposit (CGT events H1 to H2) • A deposit is forfeited to you because someone else defaults. This event occurs when the deposit is forfeited, eg when a purchaser fails to complete the purchase. The capital gain is the amount of the deposit less any expenditure in connection with the prospective sale. There will be a capital loss if the incidental costs exceed the amount of the deposit. • Payment is received for an act, transaction or event which occurs to a CGT asset. This event happens, for example, if you receive a non-contractual inducement to build a factory on your land. This event occurs when the act, transaction or event occurs. There is a capital gain if the payment exceeds the incidental costs, and a capital loss in the reverse situation. This CGT event only applies if no other CGT event applies. Australian residency ends (CGT events I1 to I2)

• An individual, company or trust stops being an Australian resident. This event occurs on the change of residency. For each CGT asset that is not taxable Australian property, there is a capital gain if the market value exceeds the cost base. There will be a capital loss if the reduced cost base exceeds the market value. There are various exceptions where CGT event I1 do not apply. (Different rules apply when a person becomes an Australian resident: ¶2-280.) Reversal of rollovers (CGT events J1 to J6) • A company ceases to be a member of a wholly owned group where there has previously been a rollover. This event occurs when the membership ceases. There is a capital gain if the market value of the asset exceeds its cost base, and a capital loss if the reduced cost base exceeds the market value. • A change in relation to a replacement asset or improved asset after a previous small business rollover. This event occurs when the change in status or circumstances happens. The capital gain is the capital gain applied in the rollover. There will be no capital loss (¶2-410). • A failure to acquire a replacement asset and incur fourth element costs after a small business roll over, or the acquisition costs or fourth element costs, or both, do not cover the disregarded capital gain. These events occur at the end of the replacement asset period. The capital gain is the difference between the disregarded capital gain and the amount incurred or the disregarded capital gain (¶2-339). • A trust fails to cease to exist after rolling over the trust’s assets to a company. This event occurs when the failure happens. There is a capital gain if the market value of the asset exceeds its cost base, and a capital loss if the reduced cost base exceeds its market value. Other CGT events (CGT events K2 to K12) • A bankrupt pays an amount in relation to a debt that was taken into account in calculating a net capital loss. This event occurs when the payment is made. There will be a capital loss if the payment relates to a denied part of the loss. There cannot be a capital gain. • A deceased estate asset passes to an exempt or tax-advantaged entity. This event occurs when the person dies. There is a capital gain if the market value of the asset exceeds its cost base, and a capital loss if the reduced cost base exceeds the market value. • A CGT asset becomes trading stock. This event occurs at that time. There is a capital gain if the market value exceeds the cost base, and a capital loss if the reduced cost base exceeds the market value. • Special capital loss from collectable that has fallen in value. This event occurs when certain CGT events happen to shares in the company or interest in the trust that owns the collectable. There is a capital gain if the market value of the shares or interest (if there had not been a fall in value) exceeds the capital proceeds from the event. There will not be a capital loss. • You dispose of your pre-CGT interest in a company or trust that has post-CGT assets (¶2-260). This event occurs when another CGT event involving the shares or interest happens. There is a capital gain if the capital proceeds from the shares or interest (attributable to post-CGT assets owned by the company or trust) exceeds the assets’ cost base. There will not be a capital loss. • Balancing adjustment event happens to a depreciating asset. This is CGT event K7 which happens where a balancing adjustment event happens to a depreciating asset that has been used wholly or partly for non-business purposes. This can only apply to assets which are subject to the uniform capital allowances system, eg an asset acquired under a contract entered into after 30 June 2001. Where CGT event K7 happens, a capital gain or loss is calculated on the basis of the asset’s cost and termination value (instead of the usual CGT basis of cost base and capital proceeds), apportioned to reflect the taxable component of the decline in value. The gain or loss is treated as arising at the same time as the relevant balancing adjustment event. If the use of the asset is 100% taxable, CGT event K7 does not happen but a balancing adjustment will occur under the capital allowances system. If there is a mixed use (ie partly taxable and non-taxable), there may be both a balancing adjustment and a capital gain or loss (¶2-205). • Direct value shifts affecting your equity or loan interests in a company or trust, or entitlement to receive payments from an interest in venture capital investments. This event happens at the time the value

decreases or on entitlement to receive payments. Special rules apply for working out the capital gain and there will be no capital loss. • Forex realisation gains or losses. This event happens at the time of the forex realisation event. The capital gain or loss is the forex realisation gain or loss (TD 2006/32: determination of non-forex component of the capital gain or loss). • Foreign hybrid loss exposure adjustment. This event happens just before the end of a year of income. Entity consolidation-related events (CGT events L1 to L8) Under the consolidation of entities regime in ITAA97, the head company of a wholly owned group of entities consolidates with its wholly owned Australian entities resulting in the consolidated group being treated as a single entity for income tax purposes. Non-income tax matters (eg goods and services tax (GST) or fringe benefits tax (FBT)) do not come within the consolidation regime and they continue to be the responsibility of the individual entities within the group. When consolidation happens, various cost setting rules are imposed. These events deal with those rules and the CGT consequences which will arise.

Checklist For financial planning purposes, the more common transactions that are likely to have CGT consequences include the following: ☐ A strata title unit or land and buildings is bought or sold. ☐ A deposit on buying an asset is forfeited to the seller. ☐ A share in a company or a unit in a unit trust is bought or sold. ☐ An item of property is destroyed. ☐ An asset or item of property is created. ☐ Shares are declared worthless by the liquidator of a company. ☐ Non-assessable payments are received from your investments in a unit trust or shares. ☐ An individual, company or trust ceases to be resident for tax purposes. ☐ A balancing adjustment event happens to a depreciating asset that is used wholly or partly for non-business purposes. ☐ A lease is granted or varied.

For relevant questions to ask so as to determine if a CGT liability may arise in respect of the more common assets or transactions, see ¶2-700.

STEP 2: WHAT IS THE CAPITAL GAIN OR LOSS? ¶2-200 Cost base calculation — the information you need Having established that your transaction involves a CGT event, the next step is to work out if there is a capital gain or loss. To do this, you will normally need to know the following. • When the CGT event occurred. This is important because:

– events involving assets acquired before 20 September 1985 are generally exempt from the CGT rules (¶2-260) – the timing of the event and the date the asset was purchased may allow for indexation calculations (¶2-210) – the timing may also affect the tax year in which the capital gain or capital loss is taken into account (¶2-600). The CGT event will normally occur when the relevant contract is entered into or ownership changes. • The cost base of the asset (if you are calculating a capital gain) or the reduced cost base (if you are calculating a capital loss). The cost base and reduced cost base rules are discussed below. Modifications to the cost base rules and special rules that may apply in specific cases are discussed in ¶2-205. • The general rules on what constitute the capital proceeds of disposal and for certain CGT events, modifications to the capital proceeds rules. The proceeds generally mean the amount you received, or the value of property you received, as a result of the CGT event. It also covers amounts that you were entitled to receive, even if they are not yet in your hands, unless it is clear that they will never be received (¶2-208). General rules “Costs” can include giving property. In determining the cost base of an asset, any amount incurred in a foreign currency is included at its Australian currency equivalent. While the cost base of a CGT asset is usually relevant in finding out if a capital gain has been made from a CGT event happening in relation to that asset, the cost base is not relevant for some CGT events. In these cases, the provisions dealing with the relevant CGT event (see ¶2-110) explain how a capital gain is calculated. If it is necessary to calculate the cost base of a CGT asset where there is no CGT event, the taxpayer must assume that a CGT event has occurred in relation to that asset. For a CGT asset that was purchased before 21 September 1999, an “indexation” factor is included to allow for inflation (¶2-210) when calculating a capital gain. Where the indexation option is used for this purpose, it applies to all elements of the cost base (see below) except the third element. Generally, an item of expenditure is deductible for income tax purposes or included in the cost base of an underlying asset for CGT purposes, but not both. Where a deduction for expenditure is subsequently claimed, s 110-45(2) applies to exclude the expenditure from the asset cost base (see “Deductible expenditure and recouped expenditure” below). The cost base of an asset for CGT purposes includes the cost of liabilities assumed in acquiring the asset, but only to the extent that a deduction for an amount of that liability is not otherwise claimed when it is later discharged (Taxation Determination TD 2019/D11). A taxpayer is required to reduce the cost base and reduced cost base of a CGT asset by the amount of any related “net input tax credit” (as defined in s 995-1) of the taxpayer. Cost base of asset — five elements The cost base is used when calculating the capital gain you have made when a CGT event happens to a CGT asset that you own. The cost base of a CGT asset may consist of up to five elements: • first element — the amount paid or payable to acquire the asset (or the market value of property you gave or transferred) • second element — the incidental costs incurred to acquire the asset or that relate to a CGT event (see below), but only if they are not tax deductible

• third element — the costs of owning the asset that are not tax deductible (see below) • fourth element — capital expenditure incurred, the purpose or expected effect of which is to increase or preserve the asset’s value or that relates to installing or removing the asset • fifth element — capital expenditure incurred in establishing or defending your title to the asset (eg certain legal costs dealing with a deceased’s estate) (s 110-25). Second element — incidental costs There are a number of incidental costs you may incur in relation to a CGT asset (s 110-25(3)). Except for item (9), they are costs you may have incurred to acquire the CGT asset, or that relate to the CGT event (s 110-35). (1) remuneration for the services of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal adviser (Bosanac v FC of T 2019 ATC ¶10-499: commissions/fees). Tax advice can be included if it is provided by a recognised tax adviser (except expenditure for professional tax advice incurred before 1 July 1989) (2) costs of transfer (3) stamp duty or other similar duty (4) costs of advertising or marketing to find a seller or buyer (an example of marketing expenses is furniture hire to help sell an investment property) (5) costs relating to any valuation or apportionment (6) search fees relating to a CGT asset (these essentially relate to fees payable in checking land titles and similar fees and not costs such as travelling expenses to find an asset suitable for purchase) (7) cost of a conveyancing kit or a similar cost (8) borrowing expenses (such as loan application fees and mortgage discharge fees) (9) expenditure incurred by the head company of a consolidated group to a non-group member that reasonably relates to a CGT asset held by the head company (10) termination or similar fee (eg an exit fee) as a direct result of ownership of an asset ending (see below). Typically, termination fees (and exit fees) are contractual fees imposed by one party on the other as a result of the second party breaking the contract. The party that imposes a termination fee may effectuate this by withholding part of the proceeds due to the other party. In this situation, the taxpayer that has to pay the termination fee cannot reduce their capital proceeds by the amount of the withheld fee. Penalty interest is an amount payable by a borrower under a loan agreement in consideration for the lender agreeing to an early repayment of the loan. This amount is commonly calculated by reference to a number of months of interest payments that would have been received but for the early repayment. Penalty interest that is an incidental cost incurred in relation to a CGT event or to acquire a CGT asset is included in the cost base or reduced cost base (Taxation Ruling TR 2019/2). Penalty interest is not a penalty under ITAA97 s 26-5 (and therefore is not excluded from the cost base or reduced cost base on that basis: s 110-38(4), 110-55(9D)). However, penalty interest is excluded from the cost base or reduced cost base to the extent it is deductible (s 110-40(2), 110-45(1B), 110-55(4), (5), (9), 110-60(2), (3), (7)). The costs incurred after a CGT event can be “related to” that CGT event for the purpose of working out incidental costs (Taxation Determination TD 2017/10). Example

Luke sells his business on 1 January 2019. Under the contract of sale, Luke receives $5,000 for the goodwill of the business. A few months later, he is sued by the purchaser for misrepresenting the value of the goodwill. Luke incurs legal fees of $1,000 to defend the action. The legal fees of $1,000 are an incidental cost of Luke's CGT asset because the fees relate to the disposal of his goodwill.

Third element This element comprises the costs of ownership of a CGT asset (as distinct from costs of becoming the owner). You must have acquired the asset after 20 August 1991. Examples of costs in the third element are rates, land taxes, repairs and insurance premiums, non-deductible interest on borrowings to finance a loan used to acquire a CGT asset and on loans used to finance capital expenditure incurred to increase an asset’s value. Income-producing assets, such as shares or rental properties, do not have a third element generally as deductible expenses are excluded (s 110-25(4)). The cost base of collectables or personal use assets (¶2-340) does not include a third element. The third element is not indexed (if working out a capital gain), and is not used when working out a capital loss (see “Reduced cost base” below). Fourth element This element covers the costs incurred which are intended or expected to increase or preserve value of the CGT asset (s 110-25(5)). The characteristics of expenditure that can come within the fourth element are as below: (1) The purpose of the expenditure need not increase the asset’s value. Instead, it is sufficient that the purpose or expected effect is to increase or preserve the asset’s value (eg legal and other expenses incurred to preserve the value of a rental property by opposing a nearby development that may adversely affect the property’s value, or costs incurred in unsuccessfully applying for zoning changes; Interpretative Decision ID 2012/46 — levy paid on conversion of overhead mains to underground cables; Coshott v FC of T 2015 ATC ¶20-508: assessment of the incidental costs, legal costs). (2) The expenditure need not be reflected in the state or nature of the asset at the time of the CGT event. (3) This element can include capital expenditure that relates to installing or moving the asset. (4) This element does not apply to capital expenditure incurred in relation to goodwill. The fourth element may be modified in certain situations involving leases (s 110-25(5), (5A), 112-80). Fifth element The fifth element is capital expenditure incurred to establish, preserve or defend the taxpayer’s title to the asset (s 110-25(6)). An amount of damages paid by a taxpayer to a potential purchaser upon the acceptance of the termination of contract to sell the asset following repudiation of the contract by the taxpayer may be included in the fifth element of the cost base of that asset (ID 2008/147). Reduced cost base The reduced cost base of an asset, which also has five elements like the cost base, is used to calculate a capital loss when a CGT event happens to a CGT asset that you own. In calculating the reduced cost base regardless of when the CGT event took place, the elements are never indexed for inflation (ie the indexation increases which may be allowed in working out the cost base of assets). All of the elements (except the third element) of the reduced cost base are the same as those for the cost base of the asset (see above) (s 110-55). The third element does not include any amount to the extent that it is tax deductible (eg building write-off deductions). The third element therefore takes into account any assessable balancing adjustments for the asset (eg where the asset had depreciated) or any non-assessable recoupment amounts that had been

received such as compensation received for damage to a property (for “Balancing adjustments and depreciating assets”, see ¶2-205). If an asset is owned partly for income-producing purposes, only a proportionate depreciation deduction is available. However, in working out the reduced cost base of the asset, the whole of the potential deduction is treated as if it were deductible. Deductible expenditure and recouped expenditure Subject to exceptions, certain expenditure is specifically prevented from forming part of the cost base (or an element of the cost base) of a CGT asset (s 110-45, 110-50, 110-53). The principal rules are as follows: • expenditure does not form part of the second or third element of the cost base to the extent that the taxpayer has deducted or can deduct it (s 110-45(1B)) • expenditure (except expenditure excluded by s 110-45(1B)) also does not form part of the cost base to the extent that the taxpayer can deduct the expenditure with certain exceptions (s 110-45(2)) • recouped expenditure does not form part of the cost base to the extent that the taxpayer has received a recoupment of it unless the recoupment is included in assessable income (s 110-45(3)). The expression “can deduct” in s 110-45 is discussed in Taxation Determination TD 2005/47. There is no fixed point in time when the question of deductibility must be determined. Expenditure excluded from cost base or reduced cost base Examples of expenditure or amounts which do not form part of the cost base or reduced cost base of a CGT asset include the following (s 110-38, 110-45, 110-55): ☐ Expenditure incurred that relates to illegal activities for which a taxpayer has been convicted of an indictable offence. ☐ Expenditure to the extent that it is a bribe to a foreign public official or a public official. ☐ Expenditure to the extent that it is in respect of providing entertainment. ☐ Expenditure to the extent that s 26-5 prevents it being deducted, even if some other provision also prevents it being deducted (s 26-5 denies deductions for penalties). ☐ Expenditure that is for political contributions and gifts that are excluded from deduction under s 2622. ☐ The excess of boat expenditure over boat income that is excluded from deduction under s 26-47. ☐ Expenditure included in the cost base of an asset may be reduced to the extent that the taxpayer can deduct it, eg interest, or to the extent that a non-assessable recoupment is received in respect of it (see “Recoupments” in ¶2-205). ☐ Capital expenditure incurred by another entity such as a previous owner in respect of the asset which the taxpayer can deduct, eg under the capital works provisions, reduces the cost base of that asset (¶2-205). Where the benefit of a deduction is effectively reversed by a balancing adjustment, the relevant expenditure is increased. Adjustments to cost base or reduced cost base Adjustments to the cost base or reduced cost base may need to be made. For example, where compensation is paid to a taxpayer for inappropriate advice that causes loss on a currently held investment, the cost base or reduced cost base (depending on whether a gain or loss is made when the investment is disposed of) should be reduced by the amount of the compensation. If the compensation is paid after the investment has been disposed of, it should be treated as additional capital proceeds (¶2208).

General rules modified in specific situations for many CGT assets The cost base rules may be subject to general modifications, while more specific cost base rules may also apply in certain cases including where a rollover occurs in respect of an asset (¶2-205).

¶2-205 Cost base modifications and special rules The general rules for working out the cost base and reduced cost base of a CGT asset (see ¶2-200) are subject to modifications in a number of circumstances. These modifications can be required at any time from when a CGT asset is acquired to when a CGT event happens in relation to that CGT asset (s 112-5). Most modifications replace the first element of the cost base and reduced cost base of a CGT asset, ie the amount paid for the CGT asset (s 112-15). If a cost base modification replaces an element of the cost base of a CGT asset with a different amount, the CGT provisions apply as if that other amount was paid. The general modification rules provided in s 112-15 to 112-37 are outlined below. Market value substitution rule The first element of the cost base and reduced cost base of a CGT asset acquired from another entity is its “market value” at the time of acquisition if: (i) the taxpayer did not incur expenditure to acquire it (except where the acquisition of the asset resulted from CGT event D1 happening or from another entity doing something that did not constitute a CGT event happening) (ii) some or all of the expenditure incurred to acquire it cannot be valued, or (iii) the taxpayer did not deal at arm’s length with the other entity in connection with the acquisition (s 112-20). A taxpayer relying on the market value substitution rule must provide sufficient evidence to prove the transaction was not at arm’s length (Healey v FC of T 2012 ATC ¶20-365). The cost base of a debt can be reduced below face value to market value in accordance with the market value substitution rule if parties entered into debt on non-arm’s length terms (QFL Photographics Pty Ltd v FC of T 2010 ATC ¶10-152). However, if the taxpayer did not deal at arm’s length with the other entity and the taxpayer’s acquisition of the CGT asset resulted from another entity doing something that did not constitute a CGT event happening (eg if the asset is a share in a company that was issued or allotted to the taxpayer by the company), then the market value is substituted only if the amount paid for the CGT asset is more than its market value at the time of acquisition. Also, the market value substitution rule does not generally apply to CGT assets in certain situations, such as: • a right to income from a trust (other than a unit trust or deceased estate) that is acquired for no consideration • a decoration awarded for valour or brave conduct that is acquired for no consideration • a contractual or other legal or equitable right resulting from CGT event D1 happening that is acquired for no consideration (see s 112-20(3) table). Split, changed or merged assets Special rules apply if a CGT asset is split into two or more assets or if it changes in whole or in part into an asset of a different nature, but only if the taxpayer remains the beneficial owner of the new assets after the change (s 112-25). A CGT event does not happen if a CGT asset is split or changed (TD 2000/10). However, the cost base and reduced cost base of each new asset are calculated by working out each element of the cost base and reduced cost base of the original asset at the time of the split or change and apportioning them in a reasonable way.

Strata title splitting One example of an asset being split is where a block of flats owned by a taxpayer under one title is converted by the taxpayer into strata title. The cost base and reduced cost base of each flat is a proportionate share of the cost base or reduced cost base of the original asset at the time when the original asset was converted to strata title. The cost base of each flat is indexed in the usual way as if it was acquired at the time when the original asset was acquired, taking into account its share of any cost base adjustments which happened up until the time of the split and the whole of any cost base adjustments in respect of that flat after the split. Similarly, the reduced cost base of each flat is worked out having regard to its share of any cost base reductions before the split and the whole of any cost base reductions in respect of the flat after the split.

Separate title Another example is where a taxpayer owns a house and adjacent land on the same title. If the taxpayer subsequently obtains a separate title for some of the adjacent land, the cost base and reduced cost base of the house and the land on which it is situated are reduced by the proportionate amount of the cost base or reduced cost base attributed to the adjacent land for which the separate title was obtained.

If two or more CGT assets are merged into a single asset, the merger is not a CGT event and each element of the cost base and reduced cost base of the new asset (at the time of merging) is the sum of the corresponding elements of each original asset (s 112-25(4)) (TD 2000/10). Apportionment If only part of the expenditure incurred in relation to a CGT asset relates to the asset, the relevant element of the cost base and reduced cost base of the asset only includes that part of the expenditure that is reasonably attributable to the acquisition of the asset (s 112-30). If a CGT event happens to some part of a CGT asset but not to the remainder of it, the cost base and reduced cost base of that part are calculated proportionately: the remainder of the cost base and reduced cost base of the asset is attributed to the part of the asset that remains (see example below). Example John acquired a truck for $24,000 and sells the motor for $9,000. Assume that the market value of the remainder of the truck is $16,000. The cost base of the motor is calculated as follows: $24,000 × $9,000 / $9,000 + $16,000 = $8,640. The cost base of the remainder of the truck is $24,000 − $8,640 = $15,360.

However, if an amount of the cost base and reduced cost base (or part of it) is wholly identifiable with the part of the asset to which the CGT event happened or to the remaining part, no apportionment is made. In such a case, the amount is allocated wholly to the relevant part of the asset. Examples where the apportionment rule applies are where a taxpayer disposes of three of 10 acres of land, where a taxpayer who owns a 30% interest in an asset disposes of a 20% interest or where the owner of an asset disposes of an interest (eg by contributing the asset to a partnership). Assumption of liability If a CGT asset is acquired from another entity and it is subject to a liability, the first element of the cost base and reduced cost base of the asset (see ¶2-200) includes the amount of the assumed liability (s 112-35). The discharge of the assumed liability is expenditure that is relevant for s 110-45(2). Earnout arrangements Special tax rules apply for the treatment of earnout rights from 24 April 2015 (ITAA97 Subdiv 118-I). Where an acquisition of business assets involves a “look-through earnout right” entered into on or after 24 April 2015, the buyer’s cost base or reduced cost base of those assets: • excludes the value of the right • is increased by any financial benefits provided by the buyer under the right, and

• is reduced by any financial benefit the buyer receives under the right (s 112-36). As financial benefits under a look-through earnout right may be provided or received for up to four years after the acquisition, the amendment period for an assessment involving such a right is four years after the expiry of the right. In addition, a taxpayer is allowed to vary a CGT choice affected by financial benefit provided or received under the right. The variation must be made by the time the taxpayer is required to lodge the tax return for the income year in which the financial benefit is provided or received (NQZG v FC of T 2020 ATC ¶10-523, [2020] AATA 379: certain payments assessable as income). Where an earnout is not a “look-through earnout right”, the Commissioner considers that: • under a standard earnout arrangement — the creation of an earnout right in the seller constitutes the giving of property by the buyer for the purposes of the cost base rules. Accordingly, when a buyer acquires a CGT asset in exchange for granting that right, the first element of the cost base of the asset includes the market value of the right (worked out at the time of acquisition). • for the seller — the first element of the cost base of the earnout right is that part (which may be all) of the market value of the original asset given by the seller in exchange for the right as is reasonably attributable to its acquisition (former Draft Ruling TR 2007/D10: withdrawn because most earnout arrangements created on or after 24 April 2015 will qualify for look-through treatment under ITAA97 Subdiv 118-I). Put options The first element of the cost base and reduced cost base of a right to dispose of a share in a company that a taxpayer acquires as a result of CGT event D2 happening is the sum of: • the amount included in the taxpayer’s assessable income as ordinary income as a result of acquiring the right, and • the amount (if any) paid by the taxpayer to acquire the right (s 112-37). If a company issues tradable put options to a shareholder, the market value of the options at the time of issue is included in the shareholder’s assessable income (FC of T v McNeil 2005 ATC 4658). This amount is not taxed again if the shareholder makes a capital gain or loss when a subsequent CGT event happens to the rights or the shares disposed of as a result of the exercise of the rights (applicable to rights issued on or after 1 July 2001). Special rules modifying cost base and reduced cost base There are many other specific situations that may require the cost base and reduced cost base of a CGT asset to be modified (s 112-40 to 112-97). Subdivision 112-B contains a number of tables (each one covering a particular topic) which describe each situation that may result in a modification to the general cost base rules. In addition, Subdiv 112-C and 112-D explain how a replacement asset rollover and a same-asset rollover will modify the cost base or reduced cost base (see “Cost base modifications in rollover of assets” below). Some of the rules affecting specific types of investments, or in particular circumstances, which require adjustments to the cost base and reduced cost base are noted below. Recoupment — limited recourse loans with shortfall in asset value Expenditure does not form part of any element of the cost base or reduced cost base to the extent of any amount received as “recoupment” of it, except so far as the amount is included in the taxpayer’s assessable income (s 110-45(3) and 110-55(6)). If a taxpayer acquires a CGT asset with funds under a limited recourse loan, and the loan was not repaid by the agreed date either by defaulting or otherwise, the market value of the asset at the time is less than the loaned amount, and the lender’s rights are limited to the CGT asset that is the security for the loan, the taxpayer will need to reduce the cost base and reduced cost base of a CGT asset by the amount of the shortfall between the loaned amount used to acquire the asset and the asset’s market value under s 110-45(3) and 110-55(6) (ID 2013/64).

A limited recourse loan protects the borrower from any potential economic loss caused by the reduction in value of the CGT asset. In this circumstance, by accepting the value of an asset that is worth less than the loaned amount as full satisfaction of the loan, the lender has compensated the taxpayer for any loss incurred as a result of the decrease in market value of the asset. By defaulting, the taxpayer has obtained an economic gain equivalent to the shortfall amount. That is, notwithstanding that the proceeds from the disposal of the underlying asset are insufficient to repay the loan in full, the taxpayer does not have to repay the shortfall amount. Therefore, the shortfall amount is regarded as having been indirectly received by the taxpayer as a reduction of the loaned amount, ie a “recoupment” under s 20-25 of the ITAA97. Bonus shares and units Bonus shares issued in place of an assessable dividend are taken to have been acquired at that time and their cost base includes the amount of the dividend. If not, they are taken to have been acquired at the same time as the original shares, with the result that they will be CGT exempt if the original shares were pre-CGT. If the original shares were post-CGT, the cost base of the bonus shares is calculated by spreading the cost of the original shares over the total number of original and bonus shares (ID 2013/19: bonus shares acquired before 1 July 1998 and disposed of subsequently). Similar rules apply to bonus units. Example Sam bought 400 shares in OPT Ltd for $1 each — 100 shares on 1 June 1985 and 300 shares on 27 May 1986. On 15 November 1986, Sam received 400 bonus shares from OPT Ltd, fully paid to $1. Sam did not have to pay anything for the bonus shares and no part of bonus shares was taxed as a dividend. The acquisition date of 100 of the bonus shares is 1 June 1985 (pre-CGT) and these bonus shares are not subject to CGT. The acquisition date of the other 300 bonus shares is 27 May 1986. Their cost base is worked out by spreading the cost of the original 300 shares Sam bought on that date over both those shares and the 300 bonus shares, ie the cost base of each share will now be 50 cents.

Cost base adjustments for non-assessable payments received If you receive non-assessable payments (not dividends) in respect of the shares or units that you hold without disposing of the shares of units, cost base adjustments may be required and a capital gain may arise. You cannot make a capital loss from a non-assessable payment. Company payments If a company makes a non-assessable payment to shareholders (eg a reduction of share capital, see CGT event G1 at ¶2-110), and the non-assessable payment amount is not more than the cost base of the shares, the cost base and reduced cost base of the shares are reduced by that amount. If the nonassessable payment amount is more than the cost base, you will make a capital gain equal to the excess. In this case, the cost base and reduced cost base of the shares are reduced to nil. Managed fund payments Non-assessable payments from a managed fund (eg a unit trust that is a property trust, share trust, equity growth trust, balanced trust) are quite common. The treatment of non-assessable payments is explained below. For the grossing-up rules for discounted capital gains, see ¶2-360. If non-assessable payments are received because you hold units in a unit trust (unit), they will be shown on the distribution statement from the unit trust as: • tax-free amounts under s 104-71(3) of the ITAA97 (ie the unit trust has received certain tax concessions and can pay greater distributions to its unitholders). These amounts now only include infrastructure borrowing amounts under s 159GZZZZE and exempt income arising from shares in a pooled development fund under s 124ZM and 124ZN of the ITAA36. In this case, reduce the reduced cost base of the units by these amounts, but not the cost base • CGT-concession amounts under s 104-71(4) (ie the unit trust’s CGT discount and capital losses components of any actual distribution). There is no change to the cost base or reduced cost base of the units

• tax-exempted amounts under s 104-71(1) (ie generally made up of exempt income of the unit trust, amounts on which the trust has already paid tax or income repaid to the trust). There is no change to the cost base or reduced cost base of the units, and • tax-deferred amounts (other non-assessable amount allowed to the trust on its capital gains and accounting differences in income) under s 104-71(1). In this case, reduce both the cost base and reduced cost base of the units by these amounts. Building allowance amounts paid on or after 1 July 2001 are treated as tax-deferred amounts. If a tax-deferred amount is greater than the cost base of the unit or trust interest, the excess is a capital gain. The indexation method may be used if the units or trust interest were bought before 21 September 1999. In that case, the discount method cannot be used to work out the capital gain when the units or trust interest are later sold. Adjustments to the cost base or reduced cost base are usually made at the end of the income year during which the payments are received. However, if a CGT event happens to the unit or trust interest during the year (eg the unit is sold), the adjustments are made just before that CGT event and the adjusted cost base or reduced cost base are used to work out the capital gain or capital loss at that time. Dividend reinvestment plans If you participate in a dividend reinvestment plan, you are treated as if you had received a cash dividend and had used the cash to buy new shares. Shares acquired in this way, on or after 20 September 1985, are subject to CGT. The cost base of the new shares is the price you paid to acquire them (ie the amount of the dividend). Example Natasha owns 1,440 shares in OPT Ltd. The shares are currently worth $8 each. OPT Ltd declared a dividend of 25 cents per share. Natasha could either take the $360 dividend as cash (1,440 × 25 cents) or receive 45 additional shares in the company ($360 ÷ $8). She decided to participate in the dividend reinvestment plan and received 45 new shares on 20 December 2019. For the income tax, Natasha must include the $360 dividend in her taxable income. For CGT, she has acquired the 45 new shares on 20 December 2019 for $360.

Issued or purchased rights, options There are no immediate CGT consequences if a shareholder (or unitholder) exercises rights to acquire additional shares, units or options, and did not pay anything for the rights. In effect, the CGT liability is rolled over (deferred) until the shares, units or options are themselves disposed of. In calculating the liability on that disposal, the cost base of those assets will include any amount paid to exercise the rights. In addition, if the original holding was pre-CGT, the cost price includes the market value of the rights at the time they were exercised. Similar rules apply where the rights were purchased from an existing shareholder (or unitholder), except that the cost base of the shares, units or options includes the purchase price for the rights as well as any amount paid to exercise them. Convertible notes The conversion of a note into shares does not have any immediate CGT consequences. Instead, the CGT liability is rolled over until the shares themselves are disposed of. In calculating this liability, the cost base of those shares includes their market value at the date of conversion. However, if the note was not classed as a “traditional security”, the cost of the shares is instead taken to be the amount paid for the note plus the amount paid for the conversion. Part-disposal of parcel of shares A taxpayer who sells part of a holding of identical shares has the option of deciding which particular shares are being disposed of, or adopting the “first in, first out” method as a reasonable basis for

identification. Alternatively, average cost may be used if the shares were acquired on the same day. This also applies to units in a unit trust. Employee share schemes An employee share scheme (ESS) is a scheme where shares or rights in a company are provided to an employee in relation to their employment. A share provides an employee with an ownership interest in a company, and a right enables an employee to acquire a share in a company at some point in the future. Some companies encourage employees to participate in ESSs by offering employees shares, stapled securities, or rights (including options) to acquire them (ESS interests), at a discount. The basic rule is that a discount received on a share or rights under an ESS interest is taxed primarily under the income tax rules pursuant to ITAA97 Div 83A. The taxation on a discount received on an ESS interest will only be deferred in the limited circumstances where there is a genuine risk of forfeiture or a salary sacrifice arrangement has been entered into. A capital gain or loss arising from a CGT event (other than CGT event E4, G1 or K8) that happens to an ESS interest will be disregarded to the extent that an amount will be, but has not yet been, included in the taxpayer’s assessable income (s 130-80(1)). Where the discount received on the ESS interest is included in the employee’s assessable income in the income year of acquisition, the first element of the cost base of an ESS interest will be its market value (s 83A-30). Where the taxing point of the ESS interest is deferred, for CGT purposes the recipient will be treated as having acquired the ESS interest at the ESS deferred taxing point for its then market value (s 83A-125). For ESS interests acquired after 30 June 2009, ITAA97 Div 83A contains specific rules about how tax applies to the ESS interests (ie to shares, stapled securities and rights to acquire them (including options)), that have been provided to employees at a discount. If ESS interests have not been granted at a discount, the benefits given to employees may be taxed under other provisions of the tax law, such as CGT. Concessions for interests in small start-up companies — CGT implications A small start-up concession is available if an ESS, the company in which the interest is issued, the employer and the employee meet certain conditions (ITAA97 s 83A-33). Basically, where the conditions are met, the employees of the start-up company do not include a discount on ESS interests acquired in their assessable income and are subject to the CGT rules below: • for shares — the discount is not subject to income tax and the share, once acquired, is then subject to CGT with a cost base reset at market value • for rights — the discount is not subject to upfront taxation and the right is then subject to CGT with a cost base equal to the employee’s cost of acquiring the right (ITAA97 s 83A-30(2) and 130-80(4)). There will be no CGT on the exercise of rights and the resulting acquisition of shares (due to the availability of a CGT rollover). However, upon exercise, the exercise price of the rights will form part of the cost base of the resulting shares. The employee will generally include any CGT in his/her assessable income (as part of working out the net capital gain or loss) on disposal of the resulting shares. CGT discount The CGT discount rules (¶2-215) are modified in relation to ESS interests that are rights to acquire shares and that benefited from the small start-up concession. When determining the acquisition time for a share that has been acquired by way of exercising a right (ie the ESS interest), the acquisition time for CGT discount purposes is the time at which the right was acquired, and not the time at which the share was acquired. This will ensure that the CGT discount is available so long as the right and underlying share are sequentially held for 12 months or more (s 115-30(1) table, item 9A). Example: shares Tanya is issued with 20,000 shares in a small Australian start-up entity under an ESS. The shares at issue have a market value of $1 per share.

Tanya contributes 85¢ per share under the scheme. On acquisition, Tanya receives a discount of $3,000 which is not included in her assessable income (ie not subject to income tax). After five years, the Australian start-up entity is sold under an arrangement where Tanya receives $1.50 per share for each of shares. Her shares will have a cost base for CGT purposes of $20,000. When Tanya sells her shares she has a discount capital gain of $5,000 which is included in her net capital gain or loss for the income year. If Tanya has no other capital gains or losses for that year, and no capital losses carried forward from a previous year, the $5,000 is then included in her assessable income in that income year.

Example: right Alex is issued with 10,000 options under an ESS operated by his small Australian start-up employer for no consideration which allow him to acquire 10,000 ordinary shares in his employer after paying an exercise price of $1.50 per right (which is more than the current market value of each share of $1 per share). After five years, Alex exercises each right by paying $15,000, and then immediately sells the shares for $2.00 each and receives proceeds of $20,000. On acquisition, Alex does not include any amount in his assessable income in relation to the discount received on his options. His options will have a nil cost base for CGT purposes. There will be no CGT on exercise of his rights and receipt of his shares (due to the availability of a CGT rollover). However, on exercise, the cost base of his shares will be $1.50 per share. On the sale of his shares Alex will have a discount capital gain of $2,500 that is included in his net capital gain or loss for the income year. If Alex has no other capital gains or losses for that year, and no capital losses carried forward from a previous year, the $2,500 is then included in his assessable income for the income year.

Note that the small start-up concession applies to the exclusion of all other ESS taxation rules, ie those eligible for the small start-up concession cannot access either the $1,000 upfront concession or the deferred taxation concession (ITAA97 s 83A-35(2)(c), 83A-105(1)(ab)). Shares or rights acquired under employee share trusts If a taxpayer acquires an ESS interest as a result of an interest held in an employee share trust, the taxpayer is treated for the purposes of the ESS and CGT provisions as being absolutely entitled to the share or right (s 130-85). The capital gain or capital loss made by an employee share trust, or a beneficiary of the trust, will be disregarded to the extent that it results from either CGT event E5 or E7 from the disposal of share acquired by the trust as a result of exercising a right that was an ESS interest (s 130-90). Return of capital to shareholder or unitholder If a company returns capital to a shareholder and the payment exceeds the cost base of the shares, there will be a capital gain to the shareholder and the cost base of the shares will be reduced to nil. If the payment does not exceed the cost base, the cost base is reduced by the amount of the payment. A similar rule applies where a trust (such as a property trust) makes a tax-free payment to a unitholder. Example Christine owns units in a unit trust that she bought on 1 July 2020 for $10 each. During 2020/21, the trustee makes two tax-free payments of $1 a unit. Christine’s cost base for the units would be reduced by $2 to $8. Therefore, if Christine were to subsequently sell her units for more than their cost base at the time, she will make a capital gain equal to that excess.

Gifts If the transaction is not on commercial terms, or is a gift, it is treated as if the asset had been transferred at market value. Mergers, splits The cost base has to be split up where the one transaction covers more than one asset, or involves a part-disposal of a single asset. Conversely, cost bases have to be combined where separate assets are merged. Value shifts

The cost base of shares in a company may have to be adjusted where there has been a value shift between companies that are under common ownership. The same applies to the cost base of loans to the company. Income-producing buildings The cost base of an income-producing building acquired after 13 May 1997 is reduced by the amount of any capital write-off deductions allowed on the building. This measure is subject to transitional provisions. Balancing adjustments and depreciating assets CGT event K7 happens where a balancing adjustment event happens to a depreciating asset that has been used, or installed ready for use, wholly or partly for a non-taxable purpose (¶2-110). In broad terms, a taxable purpose is a business purpose. A capital gain or loss under CGT event K7 is calculated on the basis of the asset’s cost and termination value (instead of the usual CGT basis of cost base and capital proceeds). This is to ensure consistency of treatment between the capital allowance rules and the CGT rules. Any gain or loss is treated as arising at the same time as any balancing adjustment that may occur. If the use is 100% taxable, CGT event K7 does not apply. Instead, there will be a balancing adjustment under the capital allowances system. If the use is 100% non-taxable, there will be a capital gain/loss under CGT event K7 based on the difference between the asset’s termination value and its cost. In such a case, there will be no balancing adjustment. If there is partly taxable and partly non-taxable use, there may be both a balancing adjustment and a capital gain/loss. Any capital gain/loss is based on the difference between the termination value and the cost, apportioned to reflect the taxable component of the decline in value. Special rules apply to depreciating assets that have been allocated to a low-value pool. A capital gain or loss under CGT event K7 is ignored if the asset was acquired before 20 September 1985. If the private use of the asset is such that it falls within the personal use asset rules, capital gains are exempt if the asset was acquired for $10,000 or less and capital losses are ignored (¶2-340). The CGT discount can apply to capital gains made as a result of CGT event K7, but not the small business concessions (¶2-310). Cost base modifications in rollover of assets CGT rollovers are discussed in ¶2-410. A replacement asset rollover allows a taxpayer to defer the making of a capital gain or loss from one CGT event until a later CGT event happens (s 112-105). It involves the taxpayer’s ownership of one CGT asset ending and the acquisition of a replacement asset. If the original CGT asset was a post-CGT asset, the first element of the replacement asset’s cost base and reduced cost base is replaced by the original asset’s cost base and reduced cost base at the time the taxpayer acquired the replacement asset (s 112110). In addition, some replacement asset rollovers involve other rules that affect the cost base or reduced cost base of a replacement asset. If the original CGT asset was a pre-CGT asset, the replacement asset is also taken to be a pre-CGT asset. A same-asset rollover allows one entity (the transferor) to ignore a capital gain or loss it makes from disposing of a CGT asset to, or from creating a CGT asset in, another entity (the transferee). Any capital gain or loss is deferred until another CGT event happens in relation to the asset in the hands of the transferee (s 112-140). If the CGT asset was a post-CGT asset in the hands of the transferor, the first element of the asset’s cost base and reduced cost base in the hands of the transferee is replaced by the asset’s cost base and reduced cost base in the hands of the transferor at the time the transferee acquired it (s 112-145). If the asset was a pre-CGT asset in the hands of the transferor, it continues to be a pre-CGT asset in the hands of the transferee.

¶2-208 Capital proceeds rules

The capital proceeds from a CGT event are relevant to work out if you have made a capital gain or loss from a CGT event happening (¶2-200). Subject to certain modifications, the general rule is that the capital proceeds from a CGT event are the total of: • the money you have received, or are entitled to receive, in respect of the event happening, and • the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event). A payment mechanism directing the consideration to a related party did not change or extinguish a taxpayer’s entitlement to receive the proceeds in respect of the disposal of a property magazine business (Quality Publications Australia Pty Ltd v FC of T 2012 ATC ¶20-317). There are six modifications to the general capital proceeds rule which may be relevant: 1. Market value substitution rule — if you do not receive any capital proceeds from a CGT event, the market value of the relevant CGT asset is taken to be the amount of the capital proceeds (ITAA97 s 116-30). From the 2006/07 income year, the market value substitution rule does not apply where CGT event C2 (¶2-110) occurs in relation to certain interests in widely held entities (ie a share in a company or a unit in a unit trust where the company has at least 300 members or the trust has at least 300 unitholders and neither has concentrated ownership). 2. Apportionment rule — if payments are received in connection with a transaction that relates to more than one CGT event or to a CGT event and something else, the capital proceeds for the respective CGT events are so much of the payments as are reasonably attributable to each CGT event (ITAA97 s 116-40). 3. Non-receipt rule — the capital proceeds from a CGT event are reduced if it is unlikely that you will receive some or all of those proceeds (ITAA97 s 116-45). However, this rule only applies if the nonreceipt did not arise because of anything you did or did not do and all reasonable steps were taken to enforce payment of the unpaid amount. The amount of the reduction is the unpaid amount. 4. Repaid rule — the capital proceeds from a CGT event are reduced by any part of them that is repaid by you and by any compensation paid by you that can reasonably be regarded as a repayment of part of them (ITAA97 s 116-50). However, the capital proceeds are not reduced by any part of the payment that is deductible. The payment can include giving property. 5. Assumption of liability rule — the capital proceeds from a CGT event are increased if the entity acquiring the relevant CGT asset acquires it subject to a liability by way of security over the asset (ITAA97 s 116-55). In such a case, the capital proceeds are increased by the amount of the liability that the acquiring entity assumes. 6. Misappropriation rule — the capital proceeds from a CGT event will be reduced if an employee or agent misappropriates all or part of those proceeds. If the taxpayer later receives an amount as recoupment of all or part of the misappropriated amount, the capital proceeds will be increased by the amount received (ITAA97 s 116-60). Not all modifications can apply to all CGT events — see the table in ITAA97 s 116-25 which sets out what modifications can apply to a specific CGT event and the special rules (if any) applying to a particular event. For example, capital proceeds can include any payment you received for granting, renewing or extending the option. Also, the capital proceeds from the expiry, surrender or forfeiture of a lease include any payment (because of the lease ending) by the lessor to the lessee for expenditure of a capital nature incurred by the lessee in making improvements to the leased property.

¶2-210 Calculating the capital gain or loss Once you know the relevant cost base of the asset (¶2-200) and the capital proceeds, you can work out if there has been a capital gain or loss.

You must first see whether the CGT assets to which the CGT event has happened fall into the categories below: • personal use assets (eg a boat, furniture and other household items for personal use and enjoyment) • collectables (eg jewellery, antiques) • land, buildings and capital improvements • active assets in a small business, or • other assets. This is because special rules apply for personal use assets and collectables (¶2-340), land, buildings and capital improvements (¶2-350) and active assets in a small business (¶2-300). Special rules also apply for beneficiaries who receive a trust distribution which has benefited from the discount capital gain or small business concessions (¶2-360). Taxation Ruling TR 2011/6 sets out the business-related capital expenditure (“blackhole expenditure” in s 40-880 of ITAA97) that can be taken into account when working out a capital gain or capital loss from a CGT event. Capital gain To work out if there has been a capital gain, you generally subtract the cost base from the proceeds of disposal. Indexation To calculate the cost base of a CGT asset that was purchased before 21 September 1999, you may need to allow for inflation. This inflation adjustment is called “indexation” because it is measured by increases in the Consumer Price Index (CPI). To index the cost base, you multiply it by the percentage increase in the CPI for the period from the quarter in which the asset was acquired until the September 1999 quarter, ie the indexed cost base is “frozen” at that point. The frozen indexed cost base method is an option for certain taxpayers to work out the capital gain only if the CGT asset was purchased before 21 September 1999 (¶2-215). If the CGT asset is purchased on or after 21 September 1999, there is no indexation of cost base for any taxpayer. Example Grace sold a parcel of Friendly Bank shares for $18,000 which she had purchased in June 1995 for $15,000. Brokerage and other incidentals are $300. She chooses the indexation option (with indexation frozen up to the September 1999 quarter) to calculate the capital gain. The indexation number is 68.7 for the September 1999 quarter and 64.7 for the June 1995 quarter.

$  Capital proceeds

18,000

Less: (indexed) cost base: ($15,000 + $300) × 68.7/64.7

16,246

Capital gain

$1,754

If any part of the expenditure that was taken into account in the cost base was incurred in a quarter after the asset was acquired, indexation for that amount is calculated separately. This may apply, for example, where enhancement costs are later incurred on land that was earlier acquired. Indexation does not apply unless the person acquired the asset at least 12 months before the CGT event (TD 2002/10: (¶2-215)), or to the third element of an asset’s cost base (¶2-200). Capital loss To work out if there has been a capital loss, you subtract the capital proceeds from the reduced cost

base. The reduced cost base is not indexed. Example Trevor sells a parcel of Bonanza Mining shares for $5,000 which he had purchased for $12,000. Brokerage and other incidentals are $300.

$  Reduced cost base: $12,000 + $300 Less: capital proceeds Capital loss

12,300 5,000 $7,300

No capital gain or capital loss It can happen that a particular transaction does not produce either a capital gain or a capital loss. This will occur when the proceeds of sale are less than the (indexed) cost base, but equal to or more than the reduced cost base. In these cases, the CGT rules have no effect. Example Adam purchased pre-1 July 2001 plant for $120,000 and subsequently sells it for $85,000, at which time its adjustable value is $48,000. As a result of the disposal, an assessable balancing charge of $37,000 arises (ie $85,000 − $48,000). The reduced cost base of the plant is calculated as follows:

$  Cost of acquisition

120,000

Less: depreciation allowed

72,000

Adjustable value

48,000

Add: balancing adjustment

37,000

Reduced cost base

$85,000

As the reduced cost base is equal to the capital proceeds, neither a capital gain nor a capital loss arises.

Choice of CGT discount or indexation available in certain cases From 21 September 1999, the capital gains that are included in assessable income may be reduced by a CGT discount if the taxpayer is an individual, a trust, a complying superannuation entity or a life insurance company in respect of its complying superannuation (¶2-215). Calculating the tax To calculate a taxpayer’s tax liability in a year of income, all the capital gains and losses for the year are aggregated to see if there is a net capital gain or loss (¶2-500).

¶2-215 Discount capital gains and discount percentage A discount capital gain is a capital gain made by an “eligible taxpayer”, namely an individual, a complying superannuation entity (ie a complying superannuation fund, complying approved deposit fund (ADF) or PST), a trust, or a life insurance company in respect of its complying superannuation assets, from a CGT event happening after 11.45 am on 21 September 1999 to an asset owned by the taxpayer, where the gain is worked out without indexation of the asset’s cost base. CGT discount percentage A taxpayer’s taxable capital gain is calculated by applying the discount percentage to the discount capital

gain (as calculated without indexation of the cost base) remaining after the application of any current year or prior year capital losses (s 102-5: see ¶2-500). The CGT discount percentage is: • for a resident individual or trust — generally 50% (the discount percentage is reduced to the extent that an individual was a foreign or temporary resident during the ownership period after 8 May 2012) • for a complying superannuation entity or life insurance company — 33⅓%. Special or modified CGT discount rules apply for qualifying affordable housing and to particular taxpayers such as resident shareholders in a listed investment company (¶2-217) and certain foreign resident beneficiaries (¶2-360). Asset held for 12 months minimum To be a discount capital gain, the eligible taxpayer must have owned the asset for “at least 12 months” before the CGT event that gave rise to the gain (ITAA97 s 115-25(1)). The 12-month rule means that a period of 365 days (or 366 in a leap year) must elapse between the day on which the asset was acquired and the day on which the CGT event happens (TD 2002/10). Note this interpretation similarly applies for cost base indexation purposes under ITAA97 s 114-10(1), ie indexation is only available for a CGT asset acquired at or before 11.45 am on 21 September 1999 and at least 12 months before the CGT event (¶2-210). In some cases, if you acquire an asset within 12 months of the CGT event happening you may still be eligible for the CGT discount. For example, assets acquired under certain same-asset or replacementasset rollover (¶2-410), or under the rules applying to deceased persons (¶19-555), will generally be treated (for the purposes of claiming the CGT discount) as having been owned for at least 12 months if the collective period of ownership is at least 12 months (Hart v FC of T; Paule v FC of T 2019 ATC ¶20717; [2019] FCAFC 179: no CGT discount in a Subdiv 124-M replacement-asset rollover, no sequential or combined operation in collective period; Mangat v FC of T [2018] AATA 301: cancellation of employee share scheme interests). For purposes of the 12-month ownership rule, a pre-CGT asset of a deceased is taken to be acquired by the legal personal representative or beneficiary at the date of the death of the deceased (see the example at ¶2-220). The CGT discount is not available for the following CGT events because the 12-month ownership rule cannot be satisfied — CGT events D1 to D3, E9, F1, F2, F5, H2, J2, J5, J6 and K10 (see ¶2-110 for details of these events). Gains which are not discount capital gains A capital gain from a CGT event is not a discount capital gain in two cases: (1) where the taxpayer makes a capital gain from a CGT event happening to an asset acquired by the taxpayer more than 12 months before the CGT event under an agreement entered into within that 12month period (2) where there is change to equity interests in a company or trust in certain circumstances. The first rule prevents taxpayers from taking advantage of the CGT discount by artificially extending the period of ownership of the asset. The second rule is aimed at stopping taxpayers from obtaining the benefit of discount capital gains by purchasing assets through an existing company or trust and selling the shares or trust interest (which has been held for at least 12 months) even though the underlying asset has been held by the company or trust for less than 12 months (s 115-45). The rule does not apply to companies or trusts with 300 or more members or beneficiaries, unless there is “concentrated ownership” of the company or trust (s 115-50). Should you choose the CGT discount or indexation option to calculate your capital gains? There is no one factor which determines the basis to select the better option. The choice essentially depends on the type of asset you own, how long you have owned it, the dates you owned it and the past

rates of inflation. Also, as capital losses must be offset against capital gains before the discount is applied, your choice may depend on the amount of capital losses you have available. Asset acquired before 11.45 am on 21 September 1999 but CGT event happened after that time For assets owned for at least 12 months, you can choose to: (1) calculate the capital gain with a cost base that includes indexation frozen at 30 September 1999, or (2) calculate the capital gain without cost base indexation and reduce the non-indexed gain by the relevant CGT discount. If the assets are owned for less than 12 months, neither indexation nor the CGT discount is available. Asset acquired after 11.45 am on 21 September 1999 and CGT event happens after that time The indexation option is not available for all taxpayers in respect of CGT assets acquired on or after 21 September 1999. For assets owned for at least 12 months, you can reduce the non-indexed gain by the CGT discount. Asset owned by any other type of taxpayer (eg a company other than a life insurance company) They are not entitled to the frozen indexed cost base or CGT discount options. Rules about trusts with new capital gain and their beneficiaries Special rules apply for dealing with the net income of a trust that has a net capital gain (ITAA97 Subdiv115-C). The rules treat parts of the net income attributable to the trust’s net capital gain as capital gains made by the beneficiary entitled to those parts so as to enable the beneficiary to reduce those parts by any capital losses and unapplied net capital losses it has. In summary: • if the trust’s capital gain was reduced by either the general 50% discount or the small business 50% reduction (see ¶2-337) (but not both), then the gain is doubled. The beneficiary can then apply its capital losses to the gain before applying the appropriate discount percentage (if any) or the small business 50% reduction. • if the trust’s capital gain was reduced by both the general 50% discount and the small business 50% reduction, then the gain is multiplied by four. The beneficiary can then apply its capital losses to the gain before applying the appropriate discount percentage (if any) and the small business 50% reduction (see further ¶2-360). The trust provisions in Div 6E of Pt III of ITAA36 will exclude amounts from the beneficiary’s assessable income if necessary to prevent the beneficiary from being taxed twice on the same parts of the trust’s net income. Proposed changes — Managed investment trusts and Attribution managed investment trusts The government has proposed measures to prevent managed investment trusts (MITs) and AMITs from applying the 50% discount at the trust level for payments. This will ensure that beneficiaries that are not entitled to the CGT discount in their own right will be prevented from getting a benefit from the CGT discount being applied at the trust level and that MITs and AMITs operate as genuine flow-through tax vehicles so that income is taxed in the hands of investors as if they had invested directly. MITs and AMITs that derive a capital gain will still be able to distribute this income as a capital gain that can be discounted in the hands of the beneficiary (2018 Budget Paper No 2, p 44; MYEFO 2018/19, December 2018). The start date for the proposed measures has been revised from 1 July 2020 to the income years commencing on or after three months after the date of Royal Assent of the enabling legislation (https://ministers.treasury.gov.au/ministers/michael-sukkar-2019/media-releases/revised-start-datestechnical-superannuation-and).

¶2-217 Discount percentage for particular taxpayers? The CGT discount capital gain and discount percentages discussed in ¶2-215 are modified for certain taxpayers or in certain circumstances as outlined below. No or reduced CGT discount for foreign residents The general CGT rules that apply to foreign residents are discussed in ¶2-280. Up to 8 May 2012, the CGT discount of 50% was available to foreign resident individuals who were subject to CGT on taxable Australian property. For assets acquired after 8 May 2012, the CGT discount is generally not available to foreign and temporary resident individuals (including beneficiaries of trusts and partners in a partnership). Where a CGT event happens after 8 May 2012 and the foreign and temporary resident individuals acquired the asset before that date, or had a period of Australian residency after that date, the CGT discount must be pro-rated. The acquisition date and eligible resident days may be affected where the individual directly holds the asset but is treated as having acquired the asset on an earlier date under s 115-30 (s 115-105(3)). In addition, foreign or temporary residents on 8 May 2012 may choose to get a market value for the CGT asset as at 8 May 2012 and use a market value calculation. This will apportion the CGT discount to take into account the capital gain the individual accrued before 8 May 2012 if a market valuation of the CGT assets at 8 May 2012 has been made. The ATO’s worksheet to work out the CGT discount in the above situations is available at www.ato.gov.au/uploadedFiles/Content/MEI/downloads/cgt_discount_worksheet_35657.pdf. Additional CGT discount for qualifying affordable housing Individuals are generally entitled to a 50% discount on capital gains for assets held for at least 12 months (¶2-215). The discount applies to capital gains that are distributed or attributed to them directly, or through an interposed entity from a trust or MIT if the trust or MIT is entitled to a discount capital gain. Individuals are also entitled to an additional capital gains discount of up to 10% for capital gains on such assets to the extent they are attributable to capital gains on dwellings used to provide affordable housing for a period or periods totalling at least three years (1,095 days) (s 115-125). A dwelling is used to provide “affordable housing” where certain conditions are satisfied (ITAA97 s 980-5). The individual, trust or MIT must have used the dwelling to provide affordable housing for a period or periods totalling at least three years. An interposed entity or trust may be a trust or partnership (other than a public unit trust or superannuation fund). The calculation of the actual discount percentage is based on the number of days the dwelling was used to provide affordable housing during its ownership period and the number of days the individual owned the dwelling as a resident. Investments in listed investment companies As a general rule, a taxpayer who owns shares and receives a distribution of a capital gain as a dividend cannot benefit from any CGT discount that might have been available if the taxpayer had been an eligible taxpayer and had made the capital gain directly (see “CGT discount percentage” in ¶2-210). An exception applies for dividends received by resident shareholders from listed investment companies (LICs) which enables them to benefit from the CGT discount on assets realised by the LIC which have been held for more than 12 months. An LIC shareholder receiving a dividend that is attributable to a capital gain will be allowed a deduction that reflects the CGT discount the shareholder could have claimed if they had made the capital gain directly. This means that an individual or a trust shareholder and a complying superannuation entity shareholder will be entitled to a deduction equal to 50% and 33⅓%, respectively, of the attributable part. This has the effect that the LIC dividends have a broadly similar tax outcome to distributions to members of managed funds (ITAA97 Subdiv 115-D) (Taxation Ruling TR 2005/23).

¶2-220 Who makes the capital gain or loss? Normally it is obvious who has made the capital gain or loss. For example, if an asset is sold, it will be the seller, but special rules are necessary in particular cases so as to ensure that the CGT provisions look through certain nominee owners to the underlying owners of the CGT asset. Partnerships It is the individual partners who make the capital gain or loss, not the partnership itself. A proportionate share of the gain or loss is attributed to each partner, based on their interest in the partnership and what the partnership agreement says. If a partner retires, leaves or dies, the continuing partners are treated as if they had acquired a new asset consisting of the departing partner’s interest in the partnership assets. If a new partner is admitted, the original partners are treated as if they had disposed of an appropriate part of their interest in the partnership assets to the new partner. Tenants in common and joint tenants Two or more people may hold property (an asset) as tenants in common or as joint tenants. If a tenant in common dies, his/her interest in the property is an asset of the deceased’s estate. That is, it can only be sold or passed to a beneficiary by the legal personal representative of the estate. Each individual who owns a CGT asset as joint tenants is treated as if he/she owns a separate CGT asset, constituted by an equal interest in the asset, and is treated as if he/she owns an equal interest as a tenant in common (s 108-7). That is, if a joint tenant dies, his/her interest in the asset is taken to pass in equal shares to the surviving tenant(s), as if the interest is an asset of the deceased estate and the surviving tenants are beneficiaries. A joint tenant was liable to CGT on his share of the capital gain on the sale of an asset (property) even though he was on the title to protect the property from being sold by the other joint tenant on a whim (Gerbic v FC of T [2013] AATA 664). The cost base rules relating to other assets of the deceased estate apply to the equal shares which pass to the surviving tenants (see further: ¶19-150, ¶19-555). For the 12-month ownership period rule for CGT discount purposes (¶2-215), a surviving joint tenant is taken to have acquired the deceased’s interest in the asset (or a share of it) at the time the deceased person acquired it. Example Tom and Jerry purchased land before 20 September 1985 as joint tenants. Jerry died in December 2019. For CGT purposes, Tom is taken to have acquired Jerry’s interest in the land at market value at the date of death. Tom therefore holds his 50% interest as a pre-CGT asset, and the inherited 50% interest as a post-CGT asset (ie acquired at market value in December 2019). If Tom sells the land within 12 months of Jerry’s death, Tom will qualify for the CGT discount as Tom is taken to have acquired the inherited interest at the time the deceased acquired it (ie before 20 September 1985) for the purpose of the 12-month ownership period rule.

The separate asset rule and the CGT consequences of a tenant in common acquiring the interest of another tenant in common is discussed in Taxation Determination TD 2000/31 (¶2-350). Bankruptcy, liquidation, trusts, security holders When a person becomes bankrupt and their assets pass to the trustee in bankruptcy, this in itself does not have any CGT consequences. What the trustee subsequently does with the assets is treated as if it had been done by the bankrupt person. This means that any capital gain or loss is made by the bankrupt, not the trustee. If a mortgagee exercises a power of sale over an asset, any capital gain or loss is made by the asset’s owner, not the mortgagee. If a liquidator sells assets of the company, any capital gain or loss is made by the company, not the liquidator.

An issue on the disposal of the land of a company as part of a winding up where a capital gain is made is whether the liquidator is required (pursuant to ITAA36 s 254(1)) to retain an amount out of the sale proceeds to pay tax which is or will become due in respect of the gain. The Full Federal Court held in FC of T v Australian Building Systems Pty Ltd (in liq) & Ors 2014 ATC ¶20-468 that liquidators and receivers and managers cannot be held personally liable for any CGT liability subsequently assessed as due, where funds are remitted in the ordinary course and to secured creditors before the Commissioner issues an assessment. That is, in the absence of a notice of assessment, there could be no obligation to retain sale proceeds for tax which had not yet been assessed. The High Court has confirmed that the liquidators were not required by s 254(1)(d) to retain any amount from the proceeds of the sale of land sufficient to pay a liability for income tax that might arise in relation to the CGT event. The s 254 payment and retention obligations arose only on the issuing of a notice of assessment (2015 ATC ¶20-548; ATO Decision Impact Statements: B19/2015, B 20/2015). Although no obligation arises under s 254, a liquidator should retain, as a matter of prudential practice, an amount from the sale of an asset to satisfy a potential tax liability until the income tax position has been ascertained by way of an assessment for the tax year in which the CGT event occurred. Additional rules ensure the proper operation of the CGT law as below: • the treatment of a bankrupt individual as the owner of an asset, rather than the trustee in bankruptcy, extends to the small business “connected entity” test (ITAA97 s 104-10(7), 106-30(1), 109-15, 328125(1) note 1) • absolutely entitled beneficiaries, companies in liquidation and security providers are treated as the owners of certain assets for CGT purposes, including the “stakeholder” tests for scrip for scrip rollover and the small business connected entity test (s 104-10(7), 106-35, 106-50, 109-15, 328125(1) notes 1 and 2), and • certain acts by a security holder which are treated as being done by the provider also applies to any act done in relation to maintaining a security, charge or encumbrance over an asset (s 106-60(2), 328-125(1) note 3). Trusts and absolutely entitled beneficiaries If an individual is a beneficiary of a trust and is absolutely entitled to a CGT asset as against the trustee of the trust (disregarding any legal disability, eg infancy or mental incapacity), the asset is treated as an asset of the individual (instead of the trust) for CGT purposes and for determining whether an entity is a small business entity. The CGT provisions therefore apply to an act done, in relation to the asset, by the trustee as if the individual had done it (s 106-50), and any capital gain or loss that arises belongs to the individual, not the trustee. With unit trusts and trust assets, the unit in the trust is treated as the relevant asset for CGT purposes (irrespective of any interest the unitholder has in the property of the unit trust at general law: see TD 2000/32). Therefore, unit trust holders are not subject to the general treatment that applies to those who are absolutely entitled for CGT purposes to the assets of a trust. Similarly, the entitlement of superannuation fund members to benefits is governed entirely by the SIS statutory regime and an entitlement to the fund’s assets does not arise under the CGT provisions. Fund members are therefore not treated as if they are absolutely entitled for CGT purposes to the assets of the fund or to assets held in the member’s account. Further guidelines on the concept of “absolute entitlement” in the CGT provisions, see Draft Taxation Ruling TR 2004/D25 and the Decision Impact Statement on Kafataris 2008 ATC ¶20-048. The grossing-up rules applying to the amount that is included in a beneficiary’s capital gains where a trust’s net capital gain has been reduced by the CGT discount (¶2-215) or the small business 50% active asset exemption (¶2-337), or both, are discussed in ¶2-360.

STEP 3: EXEMPTIONS, CONCESSIONS AND SPECIAL RULES ¶2-250 Types of exemption/concession/special rules

If you determine that you have made a capital gain or loss as discussed in ¶2-200, the next step is to identify whether there are any relevant exemptions, concessions or special rules that apply. Exemptions or concessions may apply to: • pre-CGT assets — assets purchased before 19 September 1985 (¶2-260) • exempt assets — eg a person’s main residence (¶12-500), motor cars (¶2-270) • exempt receipts or proceeds — eg life insurance policy proceeds, compensation payments, superannuation payments (¶2-270) • small business entities — eg sale of assets of the entities (¶2-300) • an individual’s assets in certain circumstances — eg family breakdown (¶18-000ff) or death (¶19000ff) • particular taxpayers — eg foreign residents, temporary residents, trust beneficiaries (¶2-280, ¶2360). Special rules apply to: • collectables (eg jewellery) or personal use assets (eg furniture, household items) (¶2-340), or • land, buildings and capital improvements (¶2-350). The ITAA97 provides many other CGT exemptions and concessions which apply to particular entities, transactions and instruments, or in particular circumstances. Readers should consult the CGT chapters in the Wolters Kluwer Australian Master Tax Guide or Federal Income Tax Reporter for details of all CGT exemptions and concessions and additional commentary. Look-through tax treatment for instalment trusts A look-through tax treatment applies to instalment trusts under ITAA97 Div 235, applicable to assets acquired by the trustee of an instalment trust. The look-through ensures that, for most income tax purposes, the consequences of ownership of an instalment trust asset flow to the entity that has the beneficial interest in the asset, instead of the trustee. For these purposes, instalment trusts include instalment warrants, instalment receipts and limited recourse borrowing arrangements by superannuation funds (s 235-825). Where look-through applies, an asset held in an instalment trust is treated as an asset of the investor and investor is treated as having the asset in the same circumstances as the investor’s interest in the instalment trust (s 235-820). Among other consequences, this treatment ensures that CGT event E5 does not apply to the trustee on the payment of the final instalment, and neither of the absolutely entitled beneficiaries provisions nor the security holder provisions (¶2-220) apply to instalment trusts (s 235-845). Special disability trusts Special disability trusts (SDTs) are used to assist families and carers to make private financial provision for the current and future care and accommodation needs of a family member with severe disability (the principal beneficiary). The two key benefits of establishing an SDT are: • immediate family members making gifts to an SDT may access a concession of up to $500,000 (combined) from the gifting rules under the social security or veterans’ entitlements laws, and • the assets of an SDT (up to a certain amount, indexed annually) plus the principal beneficiary’s principal place of residence do not impact upon the principal beneficiary’s ability to access income support payments. To qualify for the concessions, the trust must be operated in accordance with Pt 3.18A of the Social Security Act 1991 or Div 11B of Pt IIIB of the Veterans’ Entitlements Act 1986. The CGT concessions below are available to SDTs:

• Assets transferred into an SDT for no consideration are exempt from CGT. • A trustee of an SDT that holds a dwelling for use by the principal beneficiary qualifies for the CGT main residence exemption to the extent as the principal beneficiary had the principal beneficiary owned the interest in the dwelling directly — this overcomes issues which may otherwise arise, eg the trustee of the SDT is holding the dwelling and is responsible for claiming the CGT main residence exemption, but the dwelling is used by the principal beneficiary as their main residence, or the principal beneficiary cannot access the exemption as he/she does not own the dwelling. • A recipient of a principal beneficiary’s main residence may be able to access a CGT exemption if the recipient’s ownership interest ends within two years of the beneficiary’s death. • SDTs established under the Veterans’ Entitlements Act 1986 have the same taxation treatment as those established under the Social Security Act. CGT exemption for start-up investments Since 1 July 2016, a CGT exemption applies for investments made, whether directly or indirectly, in a start-up known as an Early Stage Innovation Company (“ESIC”). Generally, a company qualifies as an ESIC if it is at an early stage of its development and it is developing new or significantly improved innovations with the purpose of commercialisation to generate an economic return. Subdivision 360-A sets out the circumstances when an investor qualifies for the tax offset and the modifications to the CGT treatment of eligible investments, including the requirements to be an ESIC to report information about their investors to the Commissioner so that the ATO can assess whether these investors may qualify for the tax offset and the modified CGT treatment. An entity that is issued a share in an ESIC and is entitled to the tax offset under Subdiv 360-A (whether received or not) will be taken to hold the shares on capital account and be subject to the CGT provisions (s 360-50(1), (2)). Special provisions apply to ensure a partner in a partnership is treated as an entity for these purposes (s 360-55). To the extent that a share in an ESIC is the subject of a same asset rollover or a replacement asset rollover (excluding the scrip for scrip rollover in Subdiv 124-M or the newly incorporated company rollover in Div 122), the acquiring entity is treated as acquiring the shares as at the date of the original investor (s 360-60, 360-65). Managed Investment Trusts Managed Investment Trusts (MITs) (as defined in ITAA97) are allowed to make an irrevocable election to treat gains and losses on eligible investments on capital account for taxation purposes if they satisfy the qualifying conditions in Subdiv 275-B. These trusts are referred to as AMITs. Subject to integrity rules, the election makes the CGT provisions the primary code for taxing gains and losses on the MIT’s disposal of eligible investments and enables the MIT investors to obtain the benefit of any CGT tax concessions on distributions of capital gains. An eligible entity that does not make the election is forever subject to revenue treatment on such gains and losses. The key consequences for AMITs are as follows: • the trust is treated as a fixed trust for income tax purposes • an attribution model applies to the MIT instead of the general trust provisions in ITAA36 Pt III Div 6. For income tax purposes, the trust can attribute amounts of taxable income, exempt income, nonassessable non-exempt income, tax offsets and credits to members on a fair and reasonable basis in accordance with their interests as set out in the constituent documents of the trust, and • if a trust discovers a variance between the amounts actually attributed to members for an income year and the amounts that should have been attributed, the trust can reconcile the variance in the income year that it is discovered by using the “unders and overs” regime. The benefits that may accrue to AMIT members include the following:

• a “character flow-through” model applies to ensure that amounts derived or received by the trust that are attributed to members retain the character they had in the hands of the trustee for income tax purposes • double taxation that might otherwise arise is reduced because members are able to make annual upward and downward adjustments to the cost bases of their interests in the trust, and • there is clearer taxation treatment of tax-deferred and tax-free distributions made by the trust. For distributions made in 2017/18 and future income years, MIT investors are required to adjust the cost base of their MIT units when the trust distributes an amount claimed to be non-assessable (the CGT concession amount) under ITAA97 s 104-71(4) table item 7 (s 104-71(6)). This means that MIT investors are not able to exclude the distributions they receive in relation to these non-assessable amounts in recalculating their cost base for CGT event E4 gains (s 104-107A). Proposed changes For payments from 1 July 2020, MITS and AMITs will be prevented from applying the 50% discount at the trust level (see ¶2-215).

¶2-260 Exemption for pre-CGT assets Most CGT events generally involve a CGT asset (¶2-100). In these cases, a CGT exemption applies if you acquired the asset on or before 19 September 1985 (commonly called a “pre-CGT asset”) so that any capital gain on the disposal of the pre-CGT asset is not subject to CGT, and any capital loss on the disposal cannot be taken into account under the CGT rules. Some important points to note include the following: • even though the CGT rules do not apply, the gain may be assessable under the ordinary tax rules (¶2520) • in certain limited situations, a pre-CGT asset can be converted to a post-CGT asset and therefore lose its exempt status. Under the “majority underlying interest” rule in s 149-30(1) of ITAA97, an asset stops being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not had by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985 (ID 2011/101: no new shareholders; ID 2011/107: new shareholder) • the CGT rules may apply where a taxpayer disposes of pre-CGT shares in a private company (or interests in a private trust) whose post-CGT assets, other than trading stock, comprise 75% of its net worth. In such a case, there will be a capital gain if the proceeds from the disposal which are attributable to the value of the post-CGT assets exceed the cost base of those assets. An asset is not a pre-CGT asset if it was acquired after 19 September 1985. The exception is where a CGT rollover is available, in which case an asset’s pre-CGT status may be preserved notwithstanding that it has been disposed of after 19 September 1985. Rollovers are explained at ¶2-400.

¶2-270 Exempt assets, proceeds and transactions CGT exemptions or transactions which have no CGT consequences are diverse, as outlined below (not an exhaustive list). Exempt assets Certain assets are specifically exempted from the CGT rules. The exempt assets include: • a taxpayer’s main residence. This exemption is reduced on a pro-rata basis if the residence was also used for business activities (eg a home office). Special rules apply where the residence is vacated or changed, or if it is inherited. The main residence exemption is examined in detail in Chapter 12

• a car, motor cycle or similar vehicle • a valour or brave conduct decoration (unless you purchased it) • an asset used solely to produce exempt income • trading stock of a business • active assets, including goodwill, of a small business. This exemption is part of the small business concessions (¶2-300). Proceeds Certain types of proceeds or receipts are excluded from the CGT rules. These include: • grants from certain schemes (eg Unlawful Termination Assistance scheme, Alternative Dispute Resolution Assistance Scheme) • compensation or damages for work-related wrongs or injuries (Daniels v FC of T [2012] AATA 792: assessable gains on disposal of shares) • personal injury compensation or damages (Kort v FC of T 2019 ATC ¶10-491, [2019] AATA 336: no exemption where it was not possible to dissect the portion of the lump sum damages payment attributable) • exempt capital gains under the small business retirement concessions (¶2-338) • competition prizes, gambling wins and losses • proceeds of life insurance policies • benefits payments from superannuation funds, approved deposit funds or retirement savings accounts. Transactions Certain types of transactions are excluded from the CGT rules. These include: • a capital loss made by a lessee from the expiry, surrender, forfeiture or assignment of a lease, provided that the lease was not used mainly for business purposes (this exemption does not apply to leases for 99 years or more) • conversion by a building owner to strata title • issues or allotments of shares or trust units • disposals of rights to mine in certain cases • gifts made by will under the Cultural Bequests Program • gifts of cultural property made under the Cultural Gifts Program • a capital gain or loss made by an indigenous person or indigenous holding entity where it arises in relation to a CGT asset that is either a native title or the right to be provided with a native title benefit • certain foreign currency hedging transactions (see further ¶2-343). A general exemption from CGT applies to capital gains or capital losses arising from a right or entitlement to a tax offset, deduction or similar benefit (ITAA97 s 118-37(1)). Examples are gains derived by a person who has a right to receive an urban water tax offset on the satisfaction of the right, or the person’s right to receive a reduction in land tax under an Australian law or law of a foreign country.

¶2-280 Foreign residents and temporary residents — exemptions and withholding tax A foreign resident or the trustee of a foreign trust for CGT purposes is subject to CGT only in respect of a CGT asset that is taxable Australian property (TAP) (ITAA97 s 855-10). That is, any capital gain or capital loss from a CGT event is disregarded if the CGT event happens in relation to any other type of CGT asset (see further ¶2-360). Where an Australian tax treaty applies to a foreign resident in relation to a CGT event, the definition of real property should be read in conjunction with the definition in the treaty (FC of T v Resource Capital Fund III LP 2014 ATC ¶20-451: US Double Taxation Convention). The main residence exemption is discussed in Chapter 12 of the Guide. The CGT consequences when a person ceases to be an Australian resident in relation to the main residence exemption is discussed in ¶12-051 and ¶2-215 in relation to the CGT general discount. Foreign residents, foreign trusts and taxable Australian property A “foreign resident” means a person (including a company) who is not a resident of Australia for tax purposes and a “foreign trust for CGT purposes” means a trust that is not a resident trust for CGT purposes (¶1-550). The following assets are TAP: (1) taxable Australian real property (2) an indirect interest in Australian real property (3) a business asset of a permanent establishment in Australia (4) an option or right to acquire any of the CGT assets in items 1 to 3, or (5) a CGT asset that is deemed to be TAP where a taxpayer makes an election on ceasing to be an Australian resident (see below). The above TAP list replaced the categories of assets that were collectively referred to as “assets having the necessary connection with Australia” for which foreign residents were subject to CGT before 12 December 2006. The TAP concept has significantly narrowed the range of assets on which foreign residents are subject to Australian CGT. CGT assets cannot be covered under more than one item in the TAP list. The business assets of an Australian permanent establishment do not include CGT assets that are also covered under items 1, 2 or 5. Similarly, if a CGT asset comes within both items 2 and 5, that asset is considered to be TAP under item 5. Item 1 — Taxable Australian real property A CGT asset is taxable Australian real property (TARP) if it is real property situated in Australia or a mining, quarrying or prospecting right where the minerals, petroleum or quarry materials are situated in Australia (s 855-20, 855-25; FC of T v Resource Capital Fund IV LP & Anor 2019 ATC ¶20-691, [2019] FCAFC 51). If the sum of the market values of the entity’s assets that are TARP exceeds the sum of the market values of the assets that are non-TARP, any capital gain or capital loss is not disregarded and may be included in the assessable income of the non-resident. Capital gains made by non-residents on the sale of TARP do not qualify for the 50% CGT discount from 8 May 2012. For non-residents who chose to value their TARP assets on 8 May 2012, the portion of the capital gain accrued before that date is still eligible for the CGT discount when the asset is eventually sold, while any gain that accrues after that date is not (¶2-215). Item 2 — Indirect Australian real property interest Among other objects, the foreign resident CGT regime in Div 855 of ITAA97 ensures that interests in an entity remain subject to Australia’s CGT laws if the entity’s underlying value is principally derived from Australian real property by providing that a capital gain realised by a foreign resident on an “indirect

Australian real property interest” (see s 855-25) cannot be disregarded (s 855-5). This ensures that a capital gain or capital loss made by a foreign resident may be disregarded only if the relevant CGT asset is not: • a direct or indirect interest in Australian real property, or • an asset used in carrying on a business through a permanent establishment in Australia. An indirect Australian real property interest exists where a foreign resident has a membership interest in an entity (eg a shareholding in a company, a beneficial interest in a trust or a partnership interest, but not a debt interest) and that interest passes the non-portfolio interest test and the principal asset test. Generally, an indirect Australian real property interest includes a significant interest (generally a stake of 10% or more) in an entity whose underlying value is principally derived from Australian real property. The non-portfolio interest test is consistent with the pre-12 December 2006 tax regime whereby foreign residents with a 10% or greater interest in a public company or unit trust are subject to Australian CGT. A membership interest held by a taxpayer (holding entity) in another entity (the test entity) passes the nonportfolio test if the sum of the direct participation interests of the holding entity and its associates in the test entity is at least 10% (ITAA97 s 960-195). The principal asset test requires a comparison of the sum of the market values of the entity’s taxable Australian real property (TARP) assets with the sum of the market values of its assets that are not taxable Australian real property (non-TARP) assets. The test basically determines when an entity’s underlying value is principally derived from TARP (ITAA97 s 855-30). A membership interest held by a foreign resident holding entity in the test entity passes the principal asset test if more than 50% of the market value of the test entity’s assets is attributable to TARP. An asset of an entity for the purposes of the principal asset test is anything recognised in commerce and business as having economic value to the entity at the time of the relevant CGT for which a purchaser of the entity’s membership interests would be willing to pay (ID 2012/14: cash received and intercorporate loan under an enforceable right to the payment of money under an intercorporate loan agreement). For the treatment of inter-company loans under the principal asset test, see ID 2012/14, and for discussion of the potential for the principal asset test resulting in asset duplication, see Taxpayer Alert TA 2008/20. The Full Federal Court has held that a Cayman Islands partnership was not prevented from being assessed on a capital gain on the sale of Australian shares in a mining company as a result of the Australia–U.S. Double Tax Agreement. It also held that the underlying value of the partnership’s assets for the purposes of the “principal asset” test in s 855-30 was to be determined as if the assets were offered for sale as a bundle, and not on a stand-alone basis (Resource Capital Fund III LP 2014 ATC ¶20-451). See also FC of T v Resource Capital Fund IV LP 2019 ATC ¶20-691 on valuation methods for applying the principal asset test. Where the assets of two or more entities are included in the principal asset test, the market value of new non-TARP assets arising from certain arrangements between those entities will be disregarded. In particular, certain assets that relate to liabilities located elsewhere in the corporate group will not be counted because they do not represent the group’s underlying economic value so as to prevent the double counting of those non-TARP assets. The principal asset test applies on an associate-inclusive basis (for the purpose of determining the market value of a taxable Australian real property asset) for foreign residents with indirect interests in Australian real property from 7.30 pm (AEST) on 9 May 2017. This is intended to ensure that foreign tax residents cannot avoid a CGT liability by disaggregating indirect interests in Australian real property. Item 3 — Permanent establishment in Australia Item 3 covers assets that a foreign resident has used at any time in carrying on a business through a permanent establishment in Australia. A capital gain or loss made from an asset that was used in carrying on a business through a permanent establishment in Australia is proportionately reduced if it was used in this way for only part of the period from when the taxpayer acquired it to when the CGT event happened. For the purposes of working out whether a foreign resident has used a “permanent establishment” in carrying on a business in Australia, the expression will have its meaning under any relevant tax treaty or, if no treaty exists, the default statutory definition.

Item 5 — Changing residency status CGT events I1 and I2 (¶2-110) happen when a taxpayer stops being a resident and is deemed to have disposed of its CGT assets. Assets excluded from this rule include pre-CGT assets or assets that are TAP. Conversely, subject to certain exceptions for temporary residents, where a taxpayer changes from being a foreign resident to an Australian resident, that event is deemed to trigger an acquisition of that person’s assets (other than pre-CGT assets and taxable and Australian property) at the time of becoming a resident (see below). The general effect of the above is that, from 12 December 2006, foreign investors can no longer avoid Australian CGT consequences by holding their Australian assets through interposed entities. This overcomes the tax anomaly that would otherwise arise between foreign residents investing directly in Australia and those who invest indirectly. Previously, the disposal of an interposed entity by a foreign resident would not have triggered an Australian CGT liability whereas the direct sale of Australian assets would. Foreign resident capital gains withholding payments Withholding tax at the rate of 12.5% applies to a purchaser’s payments made to foreign residents who dispose of TAP (as listed below) under contracts entered into on or after 1 July 2016: • real property in Australia (land, buildings, residential and commercial property) • lease premiums paid for the grant of a lease over real property in Australia • mining, quarrying or prospecting rights • interests in Australian entities whose majority assets consist of the above such property or interests (ie indirect interests) • options or rights to acquire the above property or interest. The tax withholding regime does not cover the following: • real property transactions with a market value under $750,000 (reduced from $2m from 1 July 2017) • transactions listed on an approved stock exchange (with some exceptions) • transactions where the foreign resident vendor is under external administration or in bankruptcy • the non-resident vendor (owner) has obtained a clearance certificate from the ATO. The TAP withholding and ATO clearance certificate procedure is discussed further in ¶12-070–¶12-072. Interests in managed funds or other fixed trusts The capital gains and losses of a resident trust are determined without regard to whether they arise from TAP, or whether the trust has non-resident beneficiaries. Any net capital gain is included in the trust's net income for the income year, calculated in accordance with s 95(1) of the ITAA36 (¶1-505). For each capital gain of the trust, ITAA97 Subdiv 115-C treats a beneficiary (whether or not the beneficiary is a non-resident) as having an extra capital gain (see ¶2-360). To provide comparable tax treatment between direct and indirect ownership of interests in fixed trusts, the special rules below apply to foreign residents that have an interest in managed funds (or other fixed trusts) whose assets are not TAP: • a capital gain or loss made by a foreign resident from a CGT event happening to an interest in a fixed trust (eg disposal of the interest) is disregarded if enough of the trust’s underlying assets are not TAP • a capital gain made by a foreign resident beneficiary in respect of an interest in a fixed trust is disregarded if the gain relates to an asset that is not TAP • an exception to CGT event E4 (capital payments to beneficiaries) applies to distributions of foreign

source income from the trustee of a trust to a foreign resident beneficiary (see further ¶2-360). Foreign resident becoming a resident If a foreign individual or company becomes an Australian resident or a trust becomes a resident for CGT purposes, the special cost base and acquisition rules below apply in respect of each CGT asset of the taxpayer just before becoming a resident: • the asset is deemed to have been acquired by the taxpayer at the time of becoming a resident, and • the first element of the cost base and reduced cost base of the asset at the time the taxpayer becomes a resident is its market value at that time. One effect of the first point is that the taxpayer will qualify for the CGT discount only if the asset has been held for at least 12 months since becoming a resident, even if the asset was owned before that time. With respect to the second point and employee share schemes, if the taxpayer owns a qualifying share or right for which the cessation time is yet to happen, the cost base of the share or right is its market value when the cessation time occurs. In all other cases, the first element of the cost base and reduced cost base of the share or right is its market value at the time the taxpayer becomes a resident. CGT concessions for temporary residents Individuals who qualify as “temporary residents” are exempt from Australian tax on certain foreign source income or capital gains. In this respect, they will be treated similarly to foreign residents, even though in many cases they would normally have been classed as residents for tax purposes. A “temporary resident” is: • a person who holds a temporary visa under the Migration Act 1958 (ie generally expatriates on temporary visas) • not an Australian resident within the meaning in the Social Security Act (most expatriates on temporary visas cannot access social security benefits available to Australian citizens or permanent visa holders), and • does not have a spouse who is an Australian resident within the meaning in the Social Security Act. A person may be a temporary resident irrespective of whether they are a resident or a foreign resident under the normal tax rules. There is no set time limit on how long a person can be a temporary resident. The CGT-related concessions for temporary residents are summarised below. Capital gains and losses Capital gains and losses made by a temporary resident are treated as if they had been made by a foreign resident. Broadly, this means that capital gains and losses are ignored for tax purposes unless the asset is TAP. For example, capital gains from the sale of Australian real estate and shares in Australian private companies will continue to be taxable, while gains in respect of portfolio interests in Australian public companies and unit trusts will be exempt. An exception applies for gains derived as a result of services or employment provided in Australia, including gains in respect of shares or rights acquired under an employee share/option scheme where the employment in relation to which the shares or rights were granted is in Australia or the shares or rights are TAP. Normally, when a foreign resident becomes an Australian resident, special rules apply to set a cost base for certain assets held by the person (see above). This will not apply, however, where the person is a temporary resident immediately after becoming an Australian resident. Ceasing to be a temporary resident Where a person ceases to be a temporary resident but remains an Australian resident (eg becomes a permanent resident), it will be necessary to establish a cost base and nominal acquisition date for any CGT assets that are brought within the CGT net by the change of residency status. The affected assets are those owned just before the change of status, and which were acquired after 19 September 1985 and

are not TAP. For these assets, the first element of the cost base or reduced cost base is deemed to be its market value at the time that the person ceased to be a temporary resident and the asset is taken to have been acquired at that time.

¶2-300 Small business CGT concessions A CGT small business entity (taxpayer) may be eligible for one or more of the following CGT concessions in ITAA97 Div 152: • the 15-year asset exemption (¶2-336) — which exempts any capital gain on the disposal of an asset held for at least 15 years when the taxpayer retires or is incapacitated • the 50% active asset exemption (¶2-337) — which exempts any capital gain on the disposal of an active asset • the small business retirement exemption (¶2-338) — which exempts capital gains on the disposal of assets (up to a lifetime limit of $500,000 for each individual) in connection with retirement of the individual • the small business asset rollover (¶2-339) — which defers any CGT liability on the disposal of assets if the capital proceeds from the disposal are used to buy another business asset (¶2-410). Basic conditions to be met Section 152-10 sets out the basic conditions that all taxpayers must satisfy in relation to a CGT event before they are entitled to concessions in relation to a capital gain, namely: (a) the entity must be a CGT small business entity or a partner in a partnership that is a CGT small business entity, or the net value of assets that the entity and related entities own must not exceed $6m, and (b) the CGT asset must be an active asset (see further ¶2-310). Additional basic conditions The following additional basic conditions must be satisfied in the following circumstances: (a) the CGT asset is a share in a company or an interest in a trust (b) the CGT event involves certain rights or interests in relation to the income or capital of a partnership (see further ¶2-310). Other general rules related to the small business CGT concessions Many other general rules affecting the operation of the small business CGT concessions must also be considered or may apply in particular cases (see ¶2-260). General approach to claiming the concessions The CGT concessions should be accessed in the following order for maximum effect: (1) first the 15-year asset exemption, as this will eliminate any capital gain in its entirety (2) after offsetting capital losses against the capital gain, the CGT discount (if eligible) (3) the 50% active asset exemption (4) the retirement exemption (subject to the $500,000 lifetime limit) (5) the replacement asset rollover relief.

A taxpayer can choose not to apply the 50% active asset exemption and instead claim the retirement exemption or business asset rollover relief, or both, in respect of the capital gain. Further information The rules governing the small business concessions are complex and a detailed discussion is outside the scope of this Guide. ATO guidelines and further information and commentary are available from: • the ATO’s Capital gains tax Guide — www.ato.gov.au/Forms/Guide-to-capital-gains-tax-2020 (and related Guides such as Personal investors guide to capital gains tax 2020 (NAT 4152) and Small business CGT concessions: www.ato.gov.au/general/capital-gains-tax/small-business-cgtconcessions) • Wolters Kluwer’s Australian Master Tax Guide and Small Business Concessions Guide. Small business CGT concessions — simplified flow chart

¶2-310 Basic conditions and additional basic conditions

The basic conditions below must be satisfied by all taxpayers to qualify for a small business CGT concession: (1) a CGT event (other than CGT event K7: see below) happens in relation to your CGT asset and the event would have resulted in a capital gain (2) at least one of the following applies: – you are a CGT small business entity (see below) for the income year – you do not carry on business (other than as a partner) but your CGT asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you (passively held assets) – the total net value of your assets and of related entities is $6m or less (the maximum net asset value test: ¶2-315) – you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in a partnership asset or an asset you own that is not an interest in a partnership asset (partner's assets) but is used in the business of the partnership, and (3) the CGT asset satisfies the active asset test (¶2-320) (ITAA97 s 152-10). Additional basic conditions must be complied with if • the CGT asset is a share or an interest in a trust — see “Additional basic conditions — CGT asset is a share or interest in a trust” below, or • the CGT event involves certain rights or interests relating to the income or capital of a partnership — see “Additional basic condition— certain rights/interests relating to income/capital of a partnership” below. CGT small business entity An entity is a “CGT small business entity” if it carries on a business and satisfies the $2m aggregated turnover test (see below). The term “business” is defined broadly for tax purposes and it includes any profession, trade, employment, vocation or calling, but not occupation as an employee. Whether a business is carried on is a question of fact. Taxation Ruling TR 2019/1 (when a company carries on a business within the meaning of ITAA97 s 328-110) provides guidelines from the case law and the key indicia considered by the courts in determining whether the activities carried on by an entity amount to the carrying on of a business. The term “CGT small business entity” (with a $2m turnover test) is used for the purposes of CGT concessions, as opposed to the “small business entity” concept (with a $10m turnover test) which is used for the purposes of eligibility for other small business tax concessions such as the simplified depreciation rules, simplified trading stock rules, and small business income tax offset (ITAA97 s 328-10, 328-110– 328-120; Doutch v FC of T 2016 ATC ¶20-592; [2017] HCASL 85) (¶1-283). The small business “connected entity” test and scrip for scrip “stakeholder” test (¶2-410) are used to determine whether an entity has the capacity to control or influence another entity by having regard to the ownership of interests in that other entity. These tests apply having regard only to the legal ownership of the relevant interests, rather than who benefits from the ownership. As a result, the tests apply to interests held by life insurance companies, superannuation funds and trusts in the same way that they apply to other types of entities. If an entity (the first entity) directly controls a second entity, and that second entity also controls a third entity, the first entity is taken to control the third entity (s 328-125(7)). The indirect control test is designed to look through business structures that include interposed entities. This ensures consistency with direct ownership structures (see below) when determining whether an entity controls another entity in an interposed structure based on legal ownership of the relevant interests.

Absolutely entitled beneficiaries, bankrupt individuals, companies in liquidation and security providers are treated as the owners of an asset for the purpose of the CGT provisions and the connected entity test (see ¶2-320). Turnover threshold test An entity can satisfy the $2m test in one of three ways: (1) the entity’s aggregated turnover for the previous income year was less than $2m (2) the entity’s aggregated turnover for the current income year, worked out as at the first day of the income year, is likely to be less than $2m, or (3) the entity’s aggregated turnover for the current income year, worked out as at the end of the current income year is actually less than $2m. The term “likely” means on the balance of probabilities, and whether an entity’s aggregated turnover is likely to be less than $2m is an objective test. Most small business entities which have an aggregated turnover in the previous income year of less than $2m will only need to consider the test in (1). However, even if the entity’s previous year aggregated turnover was greater than $2m, the entity will satisfy the $2m aggregated turnover test if it is likely that its aggregated turnover for the current income year will be less than $2m. The reference to “as at the first day of the income year” means that the assessment is based on the entity’s state of affairs as at the first day of the income year, and not that the assessment must be made on the first day of the income year. Example Ron is carrying on a business in the 2019/20 income year. He has not assessed his eligibility as a small business entity. On 1 January 2020, Ron contemplates selling one of his business assets. To determine whether he satisfies the small business entity test for access to the small business CGT concessions, Ron can work out his aggregated turnover as at 1 July 2019. However, Ron may do this at any time in the income year and undertaking the calculation in January 2020 does not affect the result.

To stop larger businesses from artificially splitting their operations to gain access to the concessions, an aggregation rule requires the annual turnover (or net assets) of other entities that are affiliates or are connected to be aggregated for the small business entity and maximum net asset value tests. Small business entity test modification — passively held assets When determining whether the small business entity test is met, special rules apply under ITAA97 s 15210(1A) or (1B) to calculate the aggregated turnover for passively held assets (see below). For this purpose, an entity (the deemed entity) that is an affiliate of, or is connected with, the owner of a passively held CGT asset is treated as an affiliate of, or connected with, the entity that uses the passively held asset in its business (the test entity) if the deemed entity is not already an affiliate of, or connected with, the test entity (ITAA97 s 152-48(2)). Apart from partnerships, a taxpayer with an active asset has to be either a small business entity or satisfy the maximum net asset value test to qualify for the small business concessions (s 152-10(1)(c)). A taxpayer who owns a CGT asset (and does not carry on a business other than as a partner in partnership; see example below) that is used in a business by the taxpayer’s affiliate or an entity connected with the taxpayer is able to access the small business concessions via the $2m aggregated turnover test (small business entity test) if the conditions in s 152-10(1A) are met. Example Peter owns land that he leases to a company he wholly owns, Petey Farm Pty Ltd, which uses the land in its farming business. Peter does not carry on a business. Peter may be able to access the small business concessions via the small business entity test depending on the aggregated turnover of Petey Farm Pty Ltd as that company, which is connected with Peter, uses Peter’s land in carrying on its business.

Passively held assets — partners and partnership assets The CGT regime operates on the basis that a partner in a partnership carries on a business. The partner is considered to carry on the business of the partnership collectively with the other partners. Individual partners make capital gains when a CGT event happens in relation to a partnership asset. An individual partner (or partners) in a partnership can access the small business CGT concessions via the small business entity test if an asset is owned by the partner, but is used in the partnership. The conditions that must be met for passively held assets in a partnership are set out in ITAA97 s 152-10(1B). Example Beau and Irene each own 50% of a supermarket building which is used in the business of a partnership carried on by Beau, Jack, Casey and Irene. The partnership trades under the name “A-One Supermarket”. Beau and Irene may be able to access the small business concessions in relation to their respective shares of the building via the small business entity test, depending on the aggregated turnover of the partnership calculated respectively for Beau and Irene. The aggregated turnover of A-One Supermarket must be calculated separately for Beau and Irene taking into account any entities that are affiliates of, or connected with, each of them respectively.

To limit the tax planning opportunities that may otherwise be available, a special rule deals with the situation where a person makes his/her CGT asset available for use in the business of more than one partnership of which the person is a partner. These opportunities arise because the partnerships do not have to be connected with the person (the test entity) under s 152-10(1B). If the partnerships are not connected with each other and they are not connected with the test entity, each partnership would then be able to calculate its aggregated turnover without having to include the annual turnover of any of the other partnerships. In these circumstances, the rule treats each partnership that is not already connected with the test entity as being connected (s 152-48(3)). Example Ralph owns a CGT asset that he makes equally available for use in the businesses of two partnerships, Partnership One and Partnership Two, of which he is a partner. The partnerships are not connected with each other or Ralph. Ralph sells the asset (being each of Ralph’s interests in the asset) that is used separately in the businesses Ralph carries on in the two partnerships. Even though the partnerships are not otherwise connected with each other, they are taken to be connected with each other under the special rule in s 152-48(3). To determine if the $2m aggregated turnover test is met, the aggregated turnover of each partnership will include the annual turnover of the other partnership.

Businesses that are winding up and passively held assets The rules in s 152-10(1A) and (1B) to increase access to the small business concessions for passively held assets via the small business entity test rely on the CGT event happening in an income year in which the asset is being used in an entity connected with the taxpayer, or the taxpayer in partnership (or held ready for use in, or inherently connected with a business carried on by the taxpayer’s affiliate). For non-passively held assets, access to the concessions is possible where the CGT event happens in a later year than that in which the asset owner ceased to carry on a business if the CGT event occurs in a year that the business is being wound up (s 328-110(5)). In such a case, the rules treat: • the entity (including a partner) as carrying on the business at a moment in time in the CGT event year, and • the CGT asset as being used in, held ready for use in, or inherently connected with the business at that same time in the CGT event year (s 152-49(2)). An entity is deemed to carry on a business in an income year if the entity is winding up a business it formerly carried on, and it was a small business entity in the income year that it stopped carrying on the business (s 328-110(5)). Additional basic conditions — CGT asset is a share or interest in a trust

To be eligible to claim the small business CGT concessions, a taxpayer must first satisfy the basic conditions set out in s 152-10(1) in relation to the capital gain (see above). If the CGT asset is a share in a company or an interest in a trust (the object entity), additional basic conditions (set out in s 152-10(2)-(2B)) must be satisfied: (1) either the taxpayer must be a CGT concession stakeholder (see ¶2-325) in the object entity just before the CGT event, or (2) entities that are CGT concession stakeholders in the object entity must have small business participation percentage totalling at least 90% in the taxpayer (3) unless the taxpayer satisfies the maximum net asset value test, the taxpayer must have carried on a business just prior to the CGT event (4) the object entity must be a CGT small business entity for the income year or satisfy the maximum net asset value test, and (5) the shares or interests in the object entity must satisfy a modified active asset test that looks through shares in companies and interests in trusts to the activities and assets of the underlying entities (ITAA97 s 152-10(2)). The modified active assets test deals with when entities are “connected with” other entities, whereby: (i) the only CGT assets or annual turnovers considered were those of the object entity, each affiliate of the object entity and each entity controlled by the object entity in the way described by ITAA97 s 328-125; (ii) each reference to 40% therein was 20%; and (iii) there was no s 328-125(6) determination in force under which certain entities were treated as not controlling others. The modified active asset test for this purpose is the active asset test as prescribed in s 152-35 (see ¶2320) subject to the assumption in s 152-10(2A). That is: • the financial instruments and cash must be inherently connected with the business and were not acquired for a purpose that included assisting an entity to satisfy this test, and • all shares and units held by the object entity are excluded. Instead, a look-through approach will be taken with the underlying assets of the later company or trust. The additional basic conditions apply on an entity basis and are intended to prevent the small business concessions from being inappropriately applied to interests in large businesses. A taxpayer at the top of a chain of companies or trusts may not qualify for the concessions in respect of shares or interests it holds (eg because the chain includes an entity with an interest in a large business), but another taxpayer in the same chain of companies or trusts may qualify for the concessions in respect of shares or interests it holds in a small business. The modified active assets test is discussed further in ¶2-320. Additional basic condition — certain rights/interests relating to income/capital of a partnership An additional basic condition must also be met if the CGT event involves the creation, transfer, variation or cessation of a right or interest that entitles an entity to: • an amount of the income or capital of a partnership, or • an amount calculated by reference to the partner's entitlement to an amount of the income or capital of a partnership (s 152-10(2C)). The condition is that the right or interest must be a membership interest of the entity in the partnership immediately after the CGT event happens or, if the CGT event involved the cessation of the right or interest — immediately before the CGT event happens (s 152-10(2C)). This ensures that the CGT small business concessions are not available for “Everett assignments”, whereby partners alienate their income by assigning rights to the future income of a partnership to an entity without giving that entity any role in the partnership. Partners seeking to reduce their income tax liability commonly use Everett assignments and similar arrangements. Such arrangements result in a CGT event occurring and would usually result in a substantial capital gain for the partner because the entitlement to future partnership profits is likely to be

substantial and cost base (ie the costs of setting up the arrangement) is likely to be minimal. Further, while in many cases the assignment or similar arrangement would be established on a non-arm’s length basis (such as with family members) and the partner would receive minimal, if any, consideration, the market value substitution rule (see ITAA97 s 116-30) would apply. This rule broadly treats the capital proceeds of a non-arm’s length transaction as being equal to the market value of the right or interest. Before the imposition of the additional basic condition in s 152-10(2C), individuals were able to substantially reduce or eliminate tax when undertaking such assignments or similar arrangements by applying the Div 152 CGT concessions to reduce or disregard any resulting capital gain. The effect of s 152-10(2C) thus ensures that the Div 152 CGT concessions are available only for a CGT event that relates to a right or interest that entitles an entity to the income or capital of a partnership (or amounts calculated by reference to a partner’s entitlement to distributions from a partnership) if the right or interest is a membership interest of the entity that has the entitlement. General rules affecting the small business concessions The following general points must be noted with respect to the Div 152 small business CGT concessions: • Additional conditions must be satisfied in order to access the 15-year asset exemption (¶2-336), the retirement exemption (¶2-338) and the replacement asset rollover concession (¶2-339) (s 152-10(3)). By contrast, the 50% active asset exemption (¶2-337) requires only the basic conditions to be met. • Before applying the concessions, a capital gain must first be reduced by capital losses (if any). This is not required if claiming the 15-year asset exemption as the whole capital gain amount will be exempt. • The concessions are not available to a capital gain that arises from CGT event K7 happening (see below). • The 15-year exemption and 50% active asset reduction do not apply to CGT events J2, J5 and J6 (about previous applications of the small business rollover relief: see ¶2-339). • Where CGT event D1 applies (about creating rights: ¶2-110), the first and third basic conditions (see above) are replaced with the condition that the right created by the taxpayer that triggers CGT event D1 must be inherently connected with a CGT asset of the taxpayer that satisfies the active asset test (s 152-12) (see “CGT event D1 happening” in ¶2-320). CGT event K7 — Depreciating assets and small business CGT concessions Under the uniform capital allowances (UCA) system, any gain or loss from a depreciating asset (see ¶1330) is included in assessable income or deductible (as a balancing adjustment) to the extent the asset was used for a taxable purpose. However, a taxpayer will make a capital gain or capital loss from a depreciating asset to the extent that the asset was used for a non-taxable purpose (ie private purposes). In that case, CGT event K7 happens when a balancing adjustment event occurs (¶2-110). The small business concessions are not available for a capital gain that arises from CGT event K7 happening. This is because the concessions relate to the use of an asset in a small business, while a capital gain from CGT event K7 on the other hand arises only from the private use of an asset. Therefore, to the extent that an asset is used in small business, CGT event K7 never applies and the small business concessions are not available when that event happens. Note, however, that if a taxpayer makes a capital gain as a result of CGT event K7, the taxpayer can claim the CGT discount on the gain, where eligible (¶2-205).

¶2-315 Maximum net asset value test An entity that does not satisfy the small business entity test (based on aggregated turnover) may still be eligible for the small business CGT concessions if the maximum net asset value test (in ITAA97 s 152-15) is met (see ¶2-310). An entity will satisfy the maximum net asset value test if, just before the CGT event that results in the capital gain, the sum of the following amounts do not exceed $6m:

(i) the net value of the CGT assets of the entity (ii) the net value of the CGT assets of any entities “connected with” the entity (iii) the net value of the CGT assets of any of the entity’s affiliates or entities connected with the entity’s affiliates (not including assets already counted in (ii)). Affiliates Only an individual or company can be an affiliate of another entity. Entities (for tax purposes) such as trusts, partnerships, and superannuation funds are not capable of being the affiliates of an entity. An individual or a company is your affiliate if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual or company. However, an individual or a company is not your affiliate merely because of the nature of the business relationship that you and the individual or company share. A partner in a partnership would not be an affiliate of another partner merely because the first partner acts, or could reasonably be expected to act, in accordance with the directions or wishes of the second partner, or in concert with the second partner, in relation to the affairs of the partnership. A similar rule applies to directors of the same company and trustees of the same trust, or the company and a director of that company. The assets of an affiliate are not included in the maximum net asset value test if those assets are not used, or held ready for use, in a business carried on by the entity or by an entity connected with the entity. Example Shane operates a pub as a sole trader. His wife, Sherry, carries on her own cleaning business (unrelated to Shane’s business). Sherry, who owns the land and building from which Shane’s pub business is conducted, leases the building to Shane. Sherry is Shane’s affiliate. When determining whether Shane satisfies the maximum net asset value test, Shane must include the market value of the land and building owned by Sherry (because it is used in his pub business) but does not include Sherry’s other assets used in her cleaning business (because they are not used in the pub business).

Guidelines on how an unpaid present entitlement of a beneficiary connected with a trust is treated for the purposes of working out whether the trust satisfies the maximum net asset value test are set out in Taxation Ruling TR 2015/4. Net value of CGT assets The net value of the CGT assets of an entity is the sum of the market values of those assets less any liabilities of the entity relating to those assets (ITAA97 s 152-20). The assets to be included in determining the net value are not restricted to business assets. All CGT assets of the entity are taken into account, with certain exceptions (see below). Provisions for long-service leave, annual leave, unearned income and tax liabilities are taken into account when determining the net value of CGT assets of an entity (TD 2007/14: what liabilities are included). Excluded from the calculation of net value of the CGT assets are certain interests in connected entities, such as shares, units or other interests (apart from debt) held in the connected entity. This is to avoid double counting as the net value of the CGT assets of the connected entity is already included in the test (s 152-20(2)(a)). If the small business entity is an individual, the following assets are disregarded when working out the net value of the CGT assets: • assets being used solely for the personal use and enjoyment of the individual or the individual’s affiliates over the ownership period of the asset (except a dwelling, or an ownership interest in a dwelling, that is the individual’s main residence, including any relevant adjacent land) (ID 2011/37: dwelling; ID 2011/39–41: personal use of a holiday house by an individual’s spouse and children

under the age of 18 and by others, with and without rent; Altnot Pty Ltd v FC of T 2013 ATC ¶10-305: spouse and personal use and enjoyment test) • rights to amounts payable out of, or to an asset of, a superannuation fund or an approved deposit fund • insurance policies on the life of an individual (s 152-20(2)(b)). It is important to note that the maximum net asset value test: • takes into account a negative net asset value of a connected entity • takes into account the assets and related liabilities of an entity and provisions for annual leave, longservice leave, unearned income and tax liabilities • in relation to a partnership, applies only to the individual partners in the partnership, and • in relation to the assets of an individual, includes only the proportion of a dwelling that was used for income-producing purposes (TD 2007/14). In working out the net value of an individual’s CGT assets, an apportioned amount of the value of certain dwellings that have been used to produce assessable income is included (see s 152-20(2A)). If an individual’s dwelling was used during all or part of its ownership period to produce assessable income and the individual satisfied ITAA97 s 118-190(1)(c) about interest deductibility to some extent, then a reasonable proportion of the value of the dwelling is included having regard to the extent of interest deduction (ID 2011/38: dwelling in s 152-20(2A) only refers to a dwelling that is an individual’s main residence).

If an asset is disregarded (eg personal use assets and main residence), any related liability is also disregarded as the liability is unconnected with assets included in the net asset value calculation. In Case 2/2010 2010 ATC ¶1-021, the AAT held that it would make no sense to exclude liabilities that are inextricably connected to the sale where it is the disposal of the asset that creates the CGT event and determines the market value of the asset which, in turn, allows the extent of the capital gain to be ascertained. To avoid double counting, the value of interests in entities connected with the taxpayer or the taxpayer’s affiliates is disregarded, as the assets underlying these interests are already counted. However, this excludes liabilities relating to such disregarded interests with the result that the liabilities are never taken into account in the net asset value calculation. As this calculation process effectively disadvantages taxpayers (as it excludes liabilities that are indirectly related to assets whose gross value has been included in the net asset calculation), liabilities relating to disregarded interests in entities connected with a taxpayer or the taxpayer’s affiliates are taken into account in calculating the net asset value (s 15220(2)(a)). Example Danny owns all the shares in AT Pty Ltd. The net asset value of AT Pty Ltd is $1m. Danny has net assets of $5.2m (not counting the value of his shareholding in AT Pty Ltd). Previously, Danny was required to work out his maximum net asset value as $6.2m, which includes AT Pty Ltd’s net asset value of $1m but excludes the value of Danny’s shares in AT Pty Ltd. Danny still owes $500,000 that he borrowed to acquire the shares in AT Pty Ltd. Danny’s $500,000 liability incurred to acquire the shares in AT Pty Ltd is excluded from the calculation, resulting in a net asset value of $6.2m. However, this has excluded a liability that is related (indirectly) to assets whose market value has been included elsewhere in the net asset calculation. Danny can include the $500,000 liability in the calculation, resulting in a maximum net asset value of $5.7m.

For cases dealing with the application of the net asset value test, see: FC of T v Byrne Hotels Qld Pty Ltd 2011 ATC ¶20-286: meaning of “liabilities” and “contingent liabilities”; Phillips v FC of T 2012 ATC ¶10245: restructuring of a company group; Syttadel Holdings Pty Ltd v FC of T 2011 ATC ¶10-199, Venturi v FC of T 2011 ATC ¶10-200: market value of assets and objective business valuation; White & Anor v FC of T 2012 ATC ¶20-301, Miley v FC of T 2019 ATC ¶10-515; [2019] AATA 5540: value of shares in a company; Cannavo v FC of T 2010 ATC ¶10-147: debts and calculation of the threshold; Bell v FC of T 2013 ATC ¶20-380: contingent liability, not a presently existing legal obligation; Excellar Pty Ltd v FC of T 2015 ATC ¶10-391: cash is an asset, liabilities are included in calculation at GST-inclusive value; Miley v FC of T 2019 ATC ¶10-515, [2019] AATA 5540: value attributable to restrictive covenants given under sale contract included in value of shares sold. Meaning of “connected with” another entity An entity is “connected with” another entity if either entity “controls” the other entity in the way described in s 328-125, or both entities are controlled in the way described in s 328-125 by the same third entity. An entity controls another entity if the first entity, its affiliates, or the first entity and its affiliates: • beneficially own, directly or indirectly, interests in the other entity that carry between them the rights to at least 40% (the “control percentage”) of any distribution of income or capital by the other entity, except where the other entity is a discretionary trust — there are special rules for discretionary trusts • if the other entity is a company — beneficially own, or have the right to acquire beneficial ownership of, shares in the company that carry between them the right to at least 40% of the voting power of the company, or • if the other entity is a discretionary trust (see below) — are the trustee of the trust (other than the Public Trustee of a state or territory) or have the power to determine the manner in which the trust powers to make payment of income or capital are exercised (Gutteridge 2013 ATC ¶10-347; Altnot 2014 ATC ¶20-454: wife of a sole director of a taxpayer company was “connected with” the taxpayer company, ATO Decision Impact Statement Ref VID 280 of 2013).

The “connected with” test has regard only to the legal ownership of the relevant interests, not who benefits from the ownership. Thus, interests held by life insurance companies, superannuation funds and trusts are covered even though the entities do not own these interests for their own benefit, but rather for the benefit of their policy holders, members or beneficiaries. Also, absolutely entitled beneficiaries, companies in liquidation and security providers are treated as the owners of assets for the purposes of the CGT provisions.

¶2-320 Active assets A CGT asset satisfies the active asset test if it is an “active asset” (see below) of the taxpayer: • for a total of at least half of the period from when the asset is acquired until the CGT event, or of ownership. • if the asset is owned for more than 15 years — for a total of at least seven and a half years during that period (s 152-35). If a business ceased to be carried on in the last 12 months (or any longer period the Commissioner allows), the relevant period is from the acquisition date until the cessation of business date. The asset does not need to be an active asset just before the CGT event. The relevant period is from when the asset is acquired until the CGT event. Example Judy ran a florist business from a shop that she has owned for eight years. She ran the business for five years, and then leased it to an unrelated party for three years before selling it. The shop satisfies the active asset test because it was actively used in Judy’s business for more than half the period of ownership, even though the property was not used in the business just before it was disposed of.

Example Alice ran a farming business on a property that she has owned for 17 years. She ran the farm for three years, and then leased it to an unrelated party for five years. She then ran the farm for another five years before retiring and leasing the farm for another four years before selling it. The farm satisfies the active asset test because it was actively used in Alice’s farming business for at least 7½ years, even though the period was not continuous and the property was not used in the business just before it was disposed of.

What is an active asset? An “active asset” is a CGT asset: • that the taxpayer owns (whether a tangible or intangible asset) and the asset is used (or held ready for use) in carrying on a business carried on (whether alone or in partnership) by the taxpayer, the taxpayer’s associates or another entity connected with the taxpayer • an intangible asset the taxpayer owns and the asset is inherently connected with the business (eg goodwill or the benefit of a restrictive covenant) (s 152-40(1)). The concept of “carrying on a business” is a longstanding feature of the income tax law and is relevant to various provisions of general and specific application, including the small business entity provisions in ITAA97 Div 328 (¶2-310) and in interpreting the meaning of “business” as set out in the note to s 15240(4) (Taxation Ruling TR 2019/1). For an asset to be used or held ready for use “in the course of carrying on a business”, the use must have a direct functional relevance to the carrying on of the normal day-to-day activities of the business directed to the gaining or production of assessable income. In that sense, the use must be a constituent part or component of the day-to-day business activities and might in that way be described as “integral” to the carrying on of the business. For an asset to be “used” in the course of carrying on a business, it must be wholly or predominantly so

used, such that any other use can only be minor or incidental. In Eichmann, the land use was for the storage of materials for use by the company when it engaged in its business activities. The Federal Court held that it was not an active asset. While it might have been a use of the land “in relation to” the carrying on of the business, it was not, of itself, an activity in the course of carrying on the business. There was no direct connection between the uses, and the business activities and the uses had no functional relevance to those activities (FC of T v Eichmann 2019 ATC ¶20-728: appeal pending). In SWPD v FC of T 2020 ATC ¶10-526, the AAT held that the taxpayer had operated a business over the relevant period and the “forestry” land in question satisfied the active asset test. The ATO has stated that this decision did not consider the active asset test and did not change the way it applies that test (Decision impact statement). Other examples of active assets include the following: trade debtors, intellectual property, a taxi licence, an interest in property from which a business is carried on, poker machine entitlement under a hotelier’s licence and the freehold of a hotel. Not active assets Assets that are not active assets include shares or units that fail the 80% test (see below), financial instruments (eg loans, debentures, share options), and assets whose main use is to derive interest, annuities, rent (eg from investment properties) or royalties. An exception applies where the main use of an asset for deriving rent was only temporary, or the asset is an intangible asset that has been substantially developed so that its market value has been substantially enhanced (see “Investment property” below). Example Andrew owns several investment properties which are all rented out. The properties are not active assets as they are used mainly to derive rent. It is not relevant that Andrew is in the rental properties business. Edward owns a motel (land and buildings) from which he runs a motel business (ie B&B and related motel activities). The motel is an active asset as it is not mainly used to derive rent. By contrast, amounts paid by residents of a mobile home park in return for the right to occupy residential sites were characterised as rent and, therefore, the asset owned by the owner and operator of the mobile home park was not an active asset (Tingari Village North Pty Ltd 2010 ATC ¶10-131).

Other examples of non-active assets are: Australian currency, a bank account, an asset disposed of by the legal personal representative who did not carry on the deceased person’s business and commercial rental properties (Rus v FC of T 2018 ATC ¶10-478; [2018] AATA 1854: largely vacant land). Investment property A company that carries on a business in a general sense as described in Taxation Ruling TR 2019/1 but whose only activity is renting out an investment property cannot claim the Div 152 small business concessions in relation to that investment property. While a company may be considered to be carrying on a business under Taxation Ruling TR 2019/1, the question of whether a company’s investment property which is used to derive rent is an active asset under s 152-40 and satisfies the active asset test in s 152-35 is a separate consideration for the purposes of Div 152. In particular, s 152-40(4)(e) excludes, among other things, assets whose main use is to derive rent (unless such use was only temporary). Such assets are excluded even if they are used in the course of carrying on a business (Draft Taxation Determination TD 2019/D4). Death of a taxpayer If an individual carrying on a business dies and his/her assets devolve to the individual’s legal personal representative (LPR), the active asset test is applied to the LPR in relation to any capital gain made when the LPR sells the assets. The LPR (a beneficiary of the individual, a surviving joint tenant, or the trustee or beneficiary of the trust established by the will of the individual) is eligible for the small business CGT concessions where: (1) the asset is disposed of within two years of the date of death (or any extended period allowed by the Commissioner), and

(2) the asset would have qualified for the concessions if the deceased had disposed of the asset immediately before death (s 152-80). Where business has ceased Where a business has ceased, an asset that was an active asset before cessation of the business may qualify for the small business concessions if it is sold within 12 months of cessation of business or any extended period allowed by the Commissioner. It is sufficient for the asset to be an active asset for the lesser of half the period of ownership or seven and a half years, irrespective of whether the business itself has actually ceased. CGT event D1 happening Where CGT event D1 happens (about creating contractual or other rights: ¶2-110), the “active asset” test does not apply. Instead, it is a basic condition that the created right which triggers CGT event D1 must be inherently connected with a CGT asset of the taxpayer that satisfies the active asset test. This effectively enables the ownership and active asset tests to be satisfied in relation to intangible assets (eg a restrictive covenant), which are assets created in another entity without it being “owned” by the taxpayer making the capital gain. Example Bob, a butcher operating as a sole trader, agrees to sell the assets of his business to Friendly Meats. As part of the agreement, Bob undertakes not to operate a butchery business within 5 km of the current business. In return for this, undertaking Friendly Meats pays Bob an amount of $10,000. The $10,000 is a capital gain arising from CGT event D1 as Bob creates a right, being a restrictive covenant, in Friendly Meats. This right qualifies as an active asset because it is inherently connected with other CGT assets of Bob that satisfy the active asset test.

A capital gain made from CGT event D2 happening (about granting, renewing or extending an option) qualifies for small business CGT relief as the CGT event happens “in relation to” the asset in respect of which the option is granted (the underlying asset) (ID 2011/45). Shares and units — 80% test A share in a company or a unit in a unit trust can be an active asset if the company or unit trust is an Australian resident and the active assets of the company or unit trust have a market value of at least 80% of the market value of all its assets. The 80% “look-through” test is applied to the active assets of a company or trust to determine whether shares in the company or interests in a trust qualify as active assets. Cash and financial instruments inherently connected with the business are counted in the 80% test. The test does not need to be applied in circumstances where it is reasonable to conclude that the test is met and the test does not fail only because of a breach of the threshold that is temporary in nature. Under this modified active assets test, for the lesser of seven and a half years or at least half the period a taxpayer has held the share or interest, at least 80% of the sum of the total market value of the assets below must have related to assets that are active assets, or cash or financial instruments that are inherently connected with a business carried on by the object entity or a later entity: • total market value of the assets of the object entity (disregarding any shares in companies or interests in trusts), and • total market value of the assets of any entity (a later entity) in which the object entity had a small business participation percentage of greater than zero, multiplied by that percentage (s 152-10(2A) (a) and (b)). Further, if these assets are held by a later entity, the assets will only be active at a time if the later entity is an entity: • that is, at the relevant time, either: (i) a CGT small business entity; or (ii) satisfies that maximum net asset value test in relation to the capital gain, and

• in which the taxpayer has a small business participation percentage of at least 20% or is a CGT concession stakeholder at the relevant time. An entity is treated as controlling another entity at a time if it has an interest of 20% or more in that other entity at that time, rather than 40% or more. This means that more entities are considered to be “connected with” one another for the purpose of this test and need to count the assets or turnover of the other entity towards their aggregate turnover or total net CGT assets. Also, in working out if one entity controls another for these purposes, any determinations by the Commissioner under ITAA97 s 328-125(6) are disregarded. Effectively, the active asset test in s 152-35 is modified to adopt a look-through approach. Rather than treating shares or interests as active assets based on the activities of the underlying company, the modified test looks through such membership interests to include the proportionate amount of the value of the assets of later entities to which the interests ultimately relate. Furthermore, the modified test only treats assets as “active” if they meet additional requirements. Assets that are not cash or financial instruments must be used in carrying on the business of a later entity (see above) that does not have both significant turnover and assets. Assets that are cash or financial instruments must be inherently connected with such a business. However, the inclusion of cash and financial instruments is subject to an integrity rule. If cash or financial instruments acquired or held for a purpose that includes ensuring the entity satisfies the additional basic conditions, they are disregarded. The rule is similar to the integrity rule for pre-CGT assets in s 104-230(8). Finally, the assets must also be held by an entity in which the taxpayer either has a small business participation percentage of 20% or more or is a CGT concession stakeholder. An individual is a CGT concession stakeholder in a company or trust if, broadly, the individual or their spouse has a CGT small business participation percentage of 20% or more in the company or trust (s 152-50, 152-55, 152-60). This condition prevents the concession from being available for interests in entities if most of the value of the assets of the entity is unrelated to its business activities. In such cases, while the entity carries on a small business, most of the value of the interest held by the taxpayer is not attributable to the small business and it is not appropriate for the small business concessions to apply to the disposal of the interest. The condition also recognises that an investment is effectively passive in nature if an entity has an interest of less than 20% in another entity.

¶2-323 Significant individual test The significant individual test in ITAA97 s 152-50 is relevant in two main situations: (1) if the CGT asset for which the CGT concession is claimed is a share in a company or an interest in a trust (see “Additional basic conditions — CGT asset is a share or interest in a trust” in ¶2-310), or (2) if the concession claimed specifically requires the test to be met (eg the retirement exemption: ¶2338, the replacement asset rollover in certain circumstances: ¶2-339). The significant individual test enables up to eight taxpayers to benefit from the full range of small business concessions (eg five taxpayers or four taxpayers and their spouses). An individual is a “significant individual” in a company or trust if the individual has a small business participation percentage (which can comprise direct and indirect percentages) in the company or trust of at least 20% (s 152-55). A person’s direct small business participation percentage in a company is the percentage of voting power that the person is entitled to exercise and any dividend payment or capital distribution that the person is entitled to receive. With a fixed trust, a person’s direct small business participation percentage is the percentage of the income and capital of the trust that the person is beneficially entitled to receive. With a discretionary trust, a person’s direct small business participation percentage in the trust is the percentage of distributions of income and capital that the person is beneficially entitled to during the income year if the trust made a distribution of income or capital. If the trust did not make a distribution of income or capital

during the income year, it will not have a significant individual during that income year. When determining an entity’s direct small business participation percentage in a trust under items 2 or 3 of the table in s 152-70(1), the references to distributions of “income” do not necessarily mean income according to ordinary concepts. They mean the income of the trust, determined according to the general law of trusts, to which a beneficiary could be entitled. Depending on the deed and/or actions of the trustee, this may be an amount that differs from the ordinary income of the trust (ID 2012/99). If a person has different percentages in a company or a trust, their participation percentage is the smaller or smallest percentage. Example Peter has shares that entitle him to 30% of any dividends and capital distributions of ABC Co. The shares do not carry any voting rights. Peter’s direct small business participation percentage in ABC Co is 0%.

A person’s indirect small business participation percentage in a company or trust is calculated by multiplying the entity’s direct participation percentage in an interposed entity with the interposed entity’s total participation percentage (both direct and indirect) in the company or trust.

¶2-325 CGT concession stakeholder A “CGT concession stakeholder” of a company or trust means: • a significant individual (¶2-323) of the company or trust, or • a spouse of a significant individual where: – for a company, the spouse holds legal or equitable interests in any number of shares in the company – for a fixed trust, the spouse is beneficially entitled to any income and capital of the trust, or – for a discretionary trust, the spouse is beneficially entitled to any income or capital distribution made in the year from the trust. CGT concession stakeholders are entitled to the small business concessions in respect of the capital gain they make on the shares or interests in a trust they own, provided they also satisfy the relevant conditions for the concession claimed. Example 1

Individual 1 is a significant individual of Company B as he/she has an indirect interest of 66.6% in Company B. Individual 2 is a significant individual of Company B as he/she has a direct interest of 33.3%.

Example 2

Scenario 1 — asset sale Assume that the assets of C Co are sold and the proceeds of sale are distributed. A1 and A2 will each qualify as significant individuals as they have at least 20% of the shares in C Co (they are also CGT concession stakeholders). B1 and B2 can also qualify provided Trust B makes a distribution of all of its income and capital for the relevant income year (or at least 33.33% of its income or capital) to B1 and/or B2. If B1 were to receive the distribution, B1 will be a significant individual and a CGT concession stakeholder. B2 will also be a CGT Concession Stakeholder as B2 is the spouse of a significant individual (B1) with an interest in C Co. Scenario 2 — share sale Assume that the B family decides to sell its interests in C Co, and all the shares of B1, B2 and Trust B in C Co are sold. As the CGT asset in question is a share in a company, two additional basic conditions must both be satisfied (see “Basic conditions” above). That is, the company must pass the significant individual test and the person who owns the shares must be a CGT concession stakeholder in the company. These conditions are met because the company has at least one significant individual (both A1 and A2). B1 will be a significant individual (on the basis of the distribution — see Scenario 1) and a concession stakeholder. Accordingly, B1 will qualify for the small business concessions. B2 will also qualify for the concessions, being a CGT concession stakeholder as the spouse of a significant individual. Trust B does not qualify for the concessions because it must be a CGT concession stakeholder. A CGT concession stakeholder is either a significant individual or a stakeholder spouse of a significant individual. Trust B (as a discretionary trust) is neither a significant individual (not an individual) nor a spouse. Accordingly, Trust B does not qualify for any of the concessions.

¶2-336 15-year asset exemption The 15-year asset exemption allows a capital gain arising from a CGT event (other than CGT event K7) happening to an asset of a small business entity to be exempt from CGT if the following conditions are met: (1) the basic conditions discussed at ¶2-310 are satisfied for the gain (2) the entity owns the asset for any period or periods totalling 15 years during the period of ownership (3) if the CGT asset is a share in a company or an interest in a trust, at all times during the period the asset was owned, the company or trust had a “significant individual” (¶2-323) (4) if the entity is an individual, the individual is aged 55 or over at the time of the CGT event and retires or is permanently incapacitated (5) if the entity is a company or trust, the entity had a significant individual throughout the period that the entity owned the asset (this person need not be the significant individual during the whole period), and the individual who was the significant individual just before the CGT event was aged 55 or over and retires or was permanently incapacitated at that time.

If a capital gain of a company or trust is exempt under the 15-year asset concession, any payment that the company or trust makes to an individual who was a CGT concession stakeholder (¶2-325) is also exempt if it is made before the later of: • two years after the CGT event, or • if the relevant CGT event occurred because of the disposal of a CGT asset — six months after the latest time a possible financial benefit becomes or could become due under a look-through earnout right relating to that CGT asset and the disposal (s 152-125(1)). The exemption in this case is limited to the percentage interest of the CGT concession stakeholder in the company or trust. Example Peter is a significant individual of Company X, owning 60% of the shares in the company, and his wife, Janne, owns the remaining 40%. The company makes a capital gain of $10,000 and claims the 15-year exemption as both Peter and Janne are 58 years of age and are planning to retire. Six months after the CGT event, Company X distributes the amount of the exempt capital gain to Peter and Janne as CGT concession stakeholders. The amount that is exempt is calculated as follows: For Peter: 60% of $10,000 = $6,000. For Janne: 40% of $10,000 = $4,000. If Company X were to distribute $8,000 each to Peter and Janne, they can exclude an amount of $6,000 and $4,000 from their assessable incomes, respectively, for the income year, with the balance likely to be assessable as a dividend (ITAA97 s 152125(3)).

¶2-337 50% active asset exemption A small business entity may claim a 50% exemption of the capital gain arising from a CGT event (other than CGT event K7: ¶2-310) happening to an active asset of the entity if the basic conditions discussed at ¶2-310 are satisfied. The capital gain must be reduced by any capital losses before it is reduced by the 50% active asset exemption. The small business entity can choose the order in which capital gains are reduced by its capital losses. If the CGT discount (¶2-215) also applies, it applies before the 50% active asset reduction. Therefore, if the small business entity is an individual, and the capital gain has already been reduced by the 50% CGT discount, the 50% active asset exemption then applies to that reduced gain so that only 25% of the original capital gain is taxable. The capital gain may then be further reduced by the small business retirement exemption (see ¶2-338), where that exemption is available. Example Laura operates a small cleaning business. She disposes of a CGT asset that she has owned for two years and used as an active asset of the business and makes a capital gain of $17,000. She qualifies for, and claims, both the CGT discount and 50% active asset exemption. Laura also has a capital loss in the income year of $3,000 from the sale of another asset. Laura’s net capital gain of $3,500 for the year is calculated as below: Step 1: $17,000 − $3,000 = $14,000 Step 2: $14,000 − (50% CGT discount × $14,000) = $7,000 Step 3: $7,000 − (50% active asset exemption × $7,000) = $3,500

¶2-338 Small business retirement exemption The small business retirement exemption allows a capital gain arising from a CGT event (other than CGT event K7: ¶2-310) happening to a CGT asset of a small business taxpayer to be exempt from CGT to the extent that the taxpayer who controls the business elects to treat the proceeds as a retirement benefit. An individual taxpayer does not need to cease business activities or retire in order to choose the exemption.

It is not necessary to receive actual capital proceeds from a CGT event in order to access the retirement exemption. For example, the exemption is available where a capital gain is made from gifting an active asset and the market value substitution rule applies or where CGT event J2, J5 or J6 (¶2-339) happens. Taxpayers who are eligible to claim this exemption are individuals carrying on business as a sole trader, partnership, private company or trust. Different conditions apply depending on whether the taxpayer is an individual or a company or trust. Individual A small business entity that is an individual can choose the retirement exemption to disregard all or part of a capital gain remaining after other concessions have applied if: • the basic conditions discussed at ¶2-310 are satisfied • the amount chosen to be disregarded (the exempt amount) is specified in writing, and • for an individual under age 55, the individual contributes an amount equal to the exempt amount to a complying superannuation fund or retirement savings account (RSA) when making the choice (if the CGT event is J2, J5 or J6) or in other cases, at the later of receiving the proceeds from the event or making the choice (s 152-305(1), 152-315). The contribution may be satisfied by transferring real property instead of money to the superannuation fund or RSA (ID 2010/217). Where the capital proceeds from a CGT event are received by an individual in instalments, the contributions are required to be made by the later of the time of the choice and the receipt of the instalment (up to the CGT exempt amount). Where the basic conditions are met, the executor of a deceased estate when preparing outstanding income tax returns of the deceased can make a choice under s 152-305(1) to disregard all or part of a capital gain made by the deceased before his death (ID 2012/39). An individual who wishes to defer or delay making a contribution can roll over the capital gain by using the small business rollover (¶2-339). Company or trust A small business entity that is a company or trust (other than a public entity) can choose the retirement exemption to disregard all or part of a capital gain remaining after other concessions have applied if: • the basic conditions are satisfied • the entity satisfies the significant individual test (¶2-323) • the amount chosen to be disregarded (the exempt amount) is specified in writing. If there are two CGT concession stakeholders (¶2-325), the company or trust must specify each stakeholder’s percentage of the exempt amount; these percentages must add up to 100%, although one may be 0% • the company or trust makes a payment to each of its CGT concession stakeholders, worked out by reference to each individual’s percentage of the exempt amount, by the later of seven days after the choice is made to disregard the capital gain or after receiving an amount of capital proceeds from the CGT event, and • if a stakeholder is under 55 years of age just before the payment is made, the company or trust must make the payment by way of a contribution to a complying superannuation fund or an RSA for the stakeholder and by notifying the fund or RSA provider that the payment is a CGT retirement exemption amount (ID 2010/217: payment to the fund in specie). CGT retirement exemption limit The exempt amount under the retirement exemption is limited to a lifetime “CGT retirement exemption limit” of the individual taxpayer or the CGT concession stakeholders of the company or trust. An individual’s lifetime limit is $500,000 reduced by any previous small business retirement exemptions. Therefore, a company or trust with two CGT concession stakeholders will effectively have a limit of $1m

($500,000 for each stakeholder). Other key points The small business CGT retirement exemption applies appropriately to capital proceeds received by individuals in instalments (s 152-305(1)). Small business taxpayers do not need to satisfy the basic conditions for the small business CGT retirement exemption if the capital gain arises from CGT event J5 or J6 (s 152-305(4)). CGT event J5 happens if the taxpayer does not acquire a replacement asset or incur relevant improvement expenditure by the end of the two-year replacement asset period. CGT event J6 happens if the cost of the replacement asset or the amount of the improvement expenditure (or both) is less than the amount of the capital gain originally deferred (see ¶2-110, ¶2-339). Example Albert sells his entire business with the intention of purchasing a new business. He claims the small business rollover. At that time he is also eligible to claim the retirement exemption. Albert is unable to find a suitable replacement asset within two years and decides instead to retire from business. Typically, CGT event J5 is triggered and as Albert has not acquired a replacement asset or incurred the relevant improvement expenditure, he would not normally satisfy the basic conditions for accessing the retirement exemption so the capital gain from CGT event J5 cannot be disregarded. The modification of the operation of s 152-305(1)(a) and (2)(a) to make satisfying the basic conditions for the retirement exemption unnecessary if the gain arises from CGT events J5 or J6 means that Albert can access the retirement exemption in these circumstances as he is no longer required to meet the basic conditions in relation to his capital gain from the J5 event.

The small business CGT retirement exemption enables CGT exempt payments to flow through small business structures involving interposed entities ultimately to a CGT concession stakeholder without adverse tax consequences (s 152-310(3), 152-325(1)). To ensure that there is no tax impact on the interposed entity, the indirect payments are: • non-assessable non-exempt income of an interposed entity • not deductible from an interposed entity’s assessable income, and • neither a dividend nor a frankable distribution. Division 7A dealing with loans to shareholders and s 109 of the ITAA36 (the deemed dividend provisions) do not apply to payments made to CGT concession stakeholders to satisfy the retirement exemption conditions (s 152-325(9)–(11)). Case study A practical analysis and case study of the small business retirement exemption is provided at ¶15-210.

¶2-339 Small business replacement asset rollover The small business rollover concession enables a small business entity to defer making a capital gain from a CGT event happening in relation to an active asset if it acquires replacement assets in certain circumstances. However, if the use of the replacement asset later changes or in certain other circumstances (ie CGT event J2, J5 or J6 happens: see below), the deferred capital gain will crystallise and the entity will make a capital gain equal to the capital gain deferred. The crystallised capital gain may be eligible for deferral under a further application of the small business rollover concession but is not eligible for the CGT discount or 50% active asset exemption. A small business entity can choose to obtain a rollover if: • the basic conditions (see ¶2-310) are satisfied • the entity chooses one or more CGT assets as replacement assets within the period starting one year

before and ending two years after the last CGT event happens in the income year for which it is choosing the rollover (replacement asset period) • the replacement asset is acquired within that same period (the Commissioner may extend the time limit) • the replacement asset is an active asset when it is acquired, or an active asset by the end of two years after the last CGT event happens in the income year for which it is choosing the rollover, and • if the replacement asset is a share in a company or an interest in a trust, the entity or a connected entity must be a significant individual of that company or trust just after it acquires the share or interest. Where a CGT event involves a look-through earnout right, the end of the replacement asset period is extended to be six months after the expiration of the right (s 104-190(1A)). Amount of gain deferred If the replacement asset rollover is chosen, the amount of capital gain remaining after other concessions have applied is disregarded to the extent it does not exceed the total of: • the acquisition consideration of the replacement asset (ie the first element of the cost base of the replacement asset), and • any incidental costs associated with that acquisition (ie the second element of the cost base of the replacement asset). If any capital gain cannot be so disregarded, a capital gain is made equal to that amount. Example An entity made an original capital gain of $100,000 which was reduced to $25,000 under other concessions. If the total of the first and second elements of the cost base of the replacement asset is $20,000, $20,000 can be disregarded under the rollover leaving a final capital gain of $5,000.

CGT events J2, J5 or J6 happening — reversal of concession A reversal of the small business asset rollover concession will arise if CGT events J2, J5 or J6 happen. • CGT event J2 happens if a taxpayer chooses a CGT asset as a replacement asset and there is a change in relation to the replacement asset or improved asset (eg the asset stops being an active asset or certain CGT events happen in relation to the asset, or the asset becomes trading stock, or the taxpayer starts to use the asset solely to produce exempt income). • CGT event J5 happens if a taxpayer fails to acquire a replacement asset and to incur fourth element expenditure after a replacement asset rollover. • CGT event J6 happens if the cost of acquisition of a replacement asset or amount of fourth element expenditure, or both, is not sufficient to cover the disregarded capital gain under the rollover (see ¶2110).

¶2-340 Special rules for personal use assets and collectables Personal use assets “Personal use assets” include assets used or kept mainly for personal use or enjoyment (eg furniture, household items, electrical goods, a boat). They do not include land and buildings or collectables. They can also arise from certain associated transactions, eg a right or option to purchase such an asset. Any capital loss that is made from a personal use asset is disregarded, regardless of its acquisition cost

(s 108-20). A capital loss cannot be made from the disposal of shares in a company or interest in a trust that owns a personal use asset that has declined in value. If a CGT event happens to a personal use asset that was acquired for $10,000 or less, any gain is disregarded, ie it is exempt from the CGT rules. If it was acquired for more than $10,000, it can give rise to a capital gain, but not a capital loss. If a number of personal use assets that would usually be sold as a set is disposed of individually, the CGT exemption applies only if the set was acquired for $10,000 or less. Collectables Assets that are “collectables” include artwork, jewellery, antiques, coins, medallions, rare folios, manuscripts or books, stamps and first day covers, including an interest in these items, or an option or debt arising from the item: Favaro v FC of T 96 ATC 4975; ID 2011/9 (now withdrawn as a restatement of the law) in regard to artwork held as a long-term investment in the expectation of capital appreciation. A collectable that is acquired for $500 or less is exempt from the CGT rules, so that there will be no capital gain or loss (ie it is disregarded) when a CGT event happens to it. Any capital loss from collectables can only be offset against capital gains from other collectables (s 10810). Capital losses derived from the disposal of indirect interests in collectables (eg shares in a company that owns a collectable) are treated as losses from collectables. The cost base of a personal use asset or collectable does not include costs such as interest on a loan used to finance the acquisition of the asset, repair costs or insurance premiums (¶2-200). If a number of collectables that would usually be sold as a set is disposed of individually, the CGT exemption applies only if the set was acquired for $500 or less. Working out capital gains and losses from collectables A capital gain from a collectable can qualify as a discount capital gain. A taxpayer can choose the order in which the capital gain from collectables is reduced by capital losses from collectables. If some or all of a capital loss from a collectable cannot be applied in an income year, the unapplied amount (a net capital loss from collectables) can be applied in the next income year for which the taxpayer has capital gains from collectables that exceed capital loss from collectables. An ordinary capital loss cannot generally be made from the disposal of shares in a company or an interest in a trust that owns a personal use asset which has declined in value. Example Amelia sells five collectables over a two-year period as follows:

Collectable

Income year of disposal

Cost base and reduced cost base

Cost base (indexed)

Capital proceeds

Collectable gain (loss)

A

Year 1

$1,500

$1,520

$1,800

$280

B

Year 1

$1,000

$1,020

$680

($320)

C

Year 2

$2,020

$2,070

$3,000

$930

D

Year 2

$4,000

$4,080

$3,860

($140)

E

Year 2

 $600

 $650

 $475

($125)

For the first income year, Amelia has a net collectable loss of $40, ie $320 (Asset B) − $280 (Asset A). For the second income year, Amelia (using the indexation method) makes a capital gain of $625, calculated as follows: $930 (Asset C) − $140 (Asset D) − $125 (Asset E) − $40 (Year 1 collectable loss) = $625 Note: In the second year, Amelia would be better off using the discount method. On this basis, the net capital gain would be: 50% × ($980 (Asset C) − $140 (Asset D) − $125 (Asset E) − $40 (Year 1 collectable loss)) = $337.50

¶2-343 Other exemptions or loss-denying transactions A capital gain or capital loss from certain transactions and in particular circumstances may be disregarded for CGT purposes. Leases not used for income-producing purposes A capital loss a lessee makes from the expiry, surrender, forfeiture or assignment of a lease (except one granted for 99 years or more) is disregarded if the lessee did not use the lease solely or mainly for income-producing purposes (s 118-40). Strata title conversions If a taxpayer owns land on which there is a building, the building is subdivided into stratum units and each unit is transferred to the entity having the right to occupy it just before the subdivision, a capital gain or loss made by the taxpayer from transferring the units is disregarded (s 118-42). In such situations, a rollover is also available for the occupiers of the building in relation to the change in the nature of their rights of occupation. Mining rights of genuine prospectors A capital gain or loss from the sale, transfer or assignment of rights to mine in certain areas of Australia is disregarded if the income from the sale, transfer or assignment is exempt because of former s 330-60 (about genuine prospectors) (s 118-45). Foreign currency hedging contracts A capital gain or loss from a hedging contract entered into solely to reduce the risk of financial loss from currency exchange rate fluctuations is disregarded (s 118-55). Gifts of property A capital gain or loss from a testamentary gift of property is disregarded (s 118-60) if it arises from a testamentary gift that would have been deductible under s 30-15 if it had not been a testamentary gift. As an anti-avoidance measure, if a testamentary gift is reacquired for less than market value by either the estate of the deceased person or an associate of the deceased person’s estate, the rules relating to the effect of death on CGT assets will apply. Relationship breakdown settlements Capital gains and losses arising from relationship breakdown settlements are generally disregarded. A capital gain or loss that is made as a result of CGT event C2 happening to a right (¶2-110) is disregarded if: • the gain or loss is made in relation to a right that directly relates to the breakdown of a relationship between spouses, and • at the time of the trigger event, the spouses involved are separated and there is no reasonable likelihood of cohabitation being resumed (s 118-75). A “spouse” includes a member of a same-sex couple. Native title and rights to native title benefits A capital gain or loss made by a taxpayer that is either an indigenous person or an indigenous holding entity is disregarded where the gain or loss happens in relation to a CGT asset that is either a native title or the right to be provided with a native title benefit, and the gain or loss happens because of one of the following: • the taxpayer transfers the CGT asset to one or more entities that are either indigenous persons or indigenous holding entities • the taxpayer creates a trust that is an indigenous holding entity over the CGT asset • the taxpayer’s ownership of the CGT asset ends (eg by cancellation or surrender), resulting in CGT

event C2 happening in relation to the CGT asset (s 118-77). Norfolk Island residents Since 1 July 2016, Norfolk Island residents are fully subject to Australia’s income tax and CGT. Under a transitional rule, capital gains or losses on CGT assets held by Norfolk Island residents before 24 October 2015 are disregarded, if the resident would have been entitled to an exemption on those gains under the law that existed before 1 July 2016, by treating such assets as if they were acquired prior to 20 September 1985 (Income Tax (Transitional Provisions) Act 1997 (ITTPA) s 102-25(2)). Other transactions and circumstances Other transactions and circumstances in which a CGT exemption may be available include those involving foreign branch gains and losses of companies, external territories, securities lending arrangements, superannuation payments, life insurance companies and demutualisation of insurance companies, offshore banking units, cancellation and buyback of shares, calculating the attributable income of a CFC, and registered emissions units or a right to receive an Australian carbon credit unit (s 118-15).

¶2-345 Earnout arrangements An earnout arrangement is an arrangement whereby as part of the sale of a business or the assets of a business, the buyer and seller are not able to agree on a fixed payment and instead agree that subsequent financial benefits may be provided, based on the future performance of the business or a related business in which the assets are used. Earnout arrangements are therefore commonly used in the sale of businesses where there is difficulty agreeing about the value of the business. In this situation, the earnout arrangement allows parties to reach a mutually acceptable arrangement despite differences in how the parties value the business by linking additional financial benefits (or, for a reverse earnout, refunds of prior financial benefits) to the future economic performance of the business. In a standard earnout arrangement, the buyer agrees to pay the seller additional amounts if certain performance thresholds are met within a particular time. In a reverse earnout arrangement, the seller agrees to repay amounts to the buyer if certain performance thresholds are not met within a particular time. Some earnout arrangements combine the features of both a standard earnout and a reverse earnout as both the buyer and seller may be obligated to provide financial benefits depending on performance. Look-through earnout rights The tax treatment affecting earnout arrangements depends on whether the earnout right is a “lookthrough earnout right”. A right will be a “look-through earnout right” where the conditions in s 118-565(1) are satisfied. The five-year requirement in s 118-565(1)(e) is treated as having never been satisfied where the arrangement includes an option to extend or renew that arrangement, or the parties enter into another arrangement over the CGT asset, so that a party could receive financial benefits over a period ending later than five years after the end of the income year in which the CGT event happens (s 118-565(2)). A look-through earnout right also includes a right to receive future financial benefits that are for ending such a defined look-through right, provided the arrangement does not result in a breach of the five-year limitation (s 118-565(3)). CGT treatment of qualifying earnout arrangements The look-through CGT treatment of qualifying earnout arrangements under Subdiv 118-I has the effect of: • disregarding any capital gain or loss relating to the creation of the right • for the buyer — treating financial benefits provided (or received) under the right as forming part of (or reducing) the cost base of the business asset acquired

• for the seller — treating financial benefits received (or provided) under the right as increasing (or decreasing) the capital proceeds of the business asset sold. For these purposes, a “financial benefit” means anything of economic value and includes property and services (s 974-160). A taxpayer disregards the capital gain or loss relating to the creation of the right arising from: • CGT event C2 (about cancellation of a CGT asset: ¶2-110) in relation to a right received, or • CGT event D1 (about the creation of a right: ¶2-110) for a right created in another entity (s 118-575). Most earnout arrangements created on or after 24 April 2015 will qualify for look-through treatment under Subdiv 118-I. In other cases, see the Commissioner’s view on the CGT consequences in former Draft Taxation Ruling TR 2007/D10 (withdrawn). CGT small business concessions The CGT small business concessions (¶2-300 and following) apply to a sale of assets involving a lookthrough earnout right by extending both the time to choose to apply the concessions and the replacement asset period.

¶2-350 Separate asset rule If an individual owns an interest in a CGT asset and they acquire another interest in that asset, the interests remain separate CGT assets for CGT purposes and do not become a single asset (Taxation Determination TD 2000/31). The interests are separate CGT assets whether the first interest was acquired before 20 September 1985 (a pre-CGT interest) or was acquired on or after 20 September 1985 (a post-CGT interest). When a CGT event affecting the interests happens (eg CGT event A1 when the asset is sold), the consequences are: • there is a separate date of acquisition for each interest • there is a separate cost base for each interest, and • capital proceeds are determined separately for each interest (see “Interest in land” below). Interest in land The general rule is that what is attached to land becomes part of the land. Special rules apply for determining whether a building or structure constructed on land or other capital improvement should be treated as an asset separate from the land. This will affect CGT calculations because the separate asset will have its own cost base and date of acquisition. The main rules are: • a post-CGT building constructed on land acquired before 20 September 1985 (pre-CGT land) is treated as a separate asset from the land. This means, for example, that it will not enjoy the exemption normally available for pre-CGT assets • a building constructed on post-CGT land is treated as a separate asset from the land if the disposal of the building would have been covered by the balancing adjustment rules, eg for depreciated assets, R&D buildings • if post-CGT land is amalgamated with adjacent pre-CGT land, the two blocks are treated as separate assets (see “Adjacent land” below) • a capital improvement (eg fencing) which is made to pre- or post-CGT land is treated as a separate asset from the land if its disposal would have been covered by the balancing adjustment rules • a post-CGT capital improvement (including an intangible capital improvement: see example below) to

a pre-CGT asset is treated as a separate asset if, at the time a CGT event happens to the original asset, the cost base of the improvement is more than both the specified threshold for the year (see “CGT improvement threshold” below) and 5% of the capital proceeds received from the CGT event. Example Tom and Jerry jointly purchased land in 1982 to build a holiday house. Jerry sold his 50% interest to Tom in 1998 (this interest then became a separate post-CGT asset for Tom). Any capital gain or capital loss Jerry made from the sale of his interest is disregarded for CGT purposes because it was a pre-CGT interest. If Tom later sells the land, the sale proceeds are attributed 50% to the pre-CGT interest and 50% to the post-CGT interest. Any capital gain or capital loss Tom makes on his pre-CGT interest in the land is disregarded for CGT purposes. If Tom makes a capital gain on his post-CGT interest in the land it would be taken into account in calculating his net capital gain or net capital loss for the income year. If Tom decides to sell only a 50% interest in the land, he can: • sell either his (50%) pre-CGT interest or his (50%) post-CGT interest, or • sell two 25% interests in the land (being 50% of his pre-CGT interest and 50% of his post-CGT interest).

CGT improvement threshold The improvement threshold is determined for two purposes — ITAA97 s 108-70 (about when a capital improvement to a pre-CGT asset is a separate asset) and s 108-75 (about capital improvements to CGT assets for which a rollover may be available). The improvement threshold, which is indexed annually, is $155,849 for 2020/21 ($153,093 for 2019/20) (ITAA97 s 108-70(2) and (3), 108-75). Adjacent land and subdivision of land If you acquire land on or after 20 September 1985 that is adjacent to land that you already owned as at 20 September 1985, it is taken to be a separate CGT asset from the original land if you amalgamate the two titles. Example: adjacent land On 2 June 1984, Danielle bought a block of land. On 10 July 2020, she bought an adjacent block. Danielle amalgamated the titles to the two blocks into one title. The second block is treated as a separate CGT asset acquired on or after 20 September 1985 and is, therefore, subject to CGT when a CGT event happens to it.

Example: intangible capital improvement John, a farmer, holds pre-CGT land; that is land acquired before 20 September 1985. John obtains council approval on 5 July 2020 to rezone and subdivide the land. Those improvements may be separate CGT assets from the land (TD 2017/1).

Collectables An interest in a collectable is itself a collectable. A capital gain or capital loss made from an interest in a collectable is disregarded if the market value of the entire collectable at the time the interest is acquired is $500 or less (see ¶2-340). If you acquire a further interest in the collectable after the market value of the entire collectable has increased to more than $500, a capital gain or capital loss may be made from the further interest. If you last acquired the interest in a collectable before 16 December 1995, a capital gain or capital loss is disregarded if you acquired the interest for $500 or less (ITTPA s 118-10). Example Sally and Janet each acquire a 50% interest in a painting in 2015, each paying 50% of the then market value ($400) of the painting.

They have each acquired a collectable (being their interest in the painting) for $200. In a later year, Sally acquires Janet’s 50% interest in the painting for $600. The painting’s market value at that time is $1,200. Sally has acquired another collectable (being the further 50% interest) for $600. Sally now has two separate assets (being the two 50% interests she acquired separately). Disposal for $2,000 — Sally disposes of the painting for $2,000. $1,000 of the sales proceeds is attributed to each of the two interests in the painting. Sally’s capital gain on the sale of her 2015 interest is disregarded because the market value of the painting in 2015 was less than $500. Sally makes a capital gain on the later year interest in the painting of $400 ($1,000 less $600, ignoring indexation). Disposal for $1,000 — Assume that the value of the painting has depreciated and Sally disposes of it for $1,000. In this case, the capital loss on the 2015 interest is disregarded. Sally makes a $100 capital loss on the later year interest (ie $600 – $500) which is available to offset against capital gains she makes from other collectables (if any).

Earnout rights — sale of business The ATO considers that an earnout right that is created under an arrangement to sell a business is treated as an asset that is separate to the business. The tax treatment of earnout rights on a sale of a business under a “look-through earnout right” arrangement entered into on or after 24 April 2015 is discussed in ¶2-345.

¶2-355 Options An option is a CGT asset. There are basically two kinds of options — a “call” option where a person grants another person an option to acquire an asset from the first person, and a “put” option where a person grants another person an option to require the first person to acquire an asset from the other person. The rules apply to an option for the disposal of assets or the issue of a share in a company, and, from 27 May 2005, to an option to create an asset. The rules also apply to the renewal or extension of an option in the same way as they apply to the granting of an option. For example, the rules apply to an option to grant a lease or easement or an option to issue units in a unit trust. Grant of option If a taxpayer grants an option to an entity, CGT event D2 happens. It follows that a capital gain (or in some cases, a capital loss) may be made by the grantor of an option in the income year in which the option is granted. If, however, the option is subsequently exercised, any capital gain or capital loss made from the grant of the option is disregarded. To work out if the grantor of an option makes a capital gain or capital loss on the grant, the capital proceeds from the grant of the option are compared with the expenditure incurred by the grantor to grant the option. The capital gain or capital loss is the difference between the two amounts. If an option is exercised, it may be necessary to apply for an amendment of an assessment for an earlier year of income (eg the grantor has a net capital gain for the earlier year as a result of granting the option). Where an option (whether a call or a put option) is granted, the grantee acquires the option when it is granted. The cost base and reduced cost base of the option to the grantee is determined in accordance with the ordinary cost base rules (¶2-200). Thus, the option fee and any incidental costs (eg legal fees and stamp duty) will be included in the cost base. Exercise of option The date of acquisition (or disposal) of a CGT asset acquired (or disposed of) on the exercise of an option applies is the date of the transaction entered into as a result of the exercise of the option, and not the date that the option was granted (CGT Determination TD 16). When an option is exercised, the usual CGT rules are modified. However, these modifications do not apply where the special CGT rules dealing with certain rights and options issued by a company or trust are involved (see below). A capital gain or loss the grantor or grantee of an option makes from the option being exercised is ignored. The cost base and reduced cost base of the option are modified for both the grantor and grantee. In the case of a call option, the first element of the grantee’s cost base and reduced cost base for the

asset acquired is what the grantee paid for the option plus any amount paid by the grantee to exercise that option. In addition, the capital proceeds for the grantor are worked out in the same way. However, if the option was granted pre-CGT and exercised post-CGT, the first element of the cost base and reduced cost base of the acquired asset includes the market value of the option at the time of exercise. In the case of a put option, the first element of the grantor’s cost base and reduced cost base for the asset acquired is the amount the grantee paid for the asset it was required to purchase because the grantee exercised the option, reduced by the amount received by the grantor for granting the option. In addition, the second element of the grantee’s cost base and reduced cost base for the asset disposed of to the grantor includes any payment the grantee made to acquire the option. Example 1 Jessica gives Mary an option to buy an investment asset for $80,000. Mary pays $10,000 for the option, and later exercises it. The first element of her cost base and reduced cost base for the asset includes the $10,000 she paid for the option. Accordingly, the first element of her cost base and reduced cost base for the asset is $90,000 (ie $80,000 + $10,000).

Example 2 Peter owns 5,000 shares in ABC Ltd. Gillian gives Peter an option which, if exercised, would require her to buy the shares for $1 each. Peter pays Gillian 20 cents per share for the option. Peter exercises the option and Gillian pays $5,000 for the shares. The first element of Gillian’s cost base and reduced cost base for the shares is $4,000 (ie $5,000 − $1,000). In working out whether Peter makes a capital gain or loss on the sale of the shares, the second element of his cost base and reduced cost base includes the $1,000 he paid for the option.

Options — company shares and units in unit trust Companies and trustees of a unit trust may issue call options to their shareholders and unitholders, and companies may issue put options to their shareholders. Under a call option, the company or trustee issues the shareholders or unitholders with rights to buy additional shares in the company or additional units in the trust. Under a put option, a company issues its shareholders with rights to sell their shares back to the company. The High Court held that the market value of tradeable put options issued by a company to its shareholders was assessable as ordinary income at the time of issue of the options (FC of T v McNeil 2007 ATC 4223). On the CGT issue in that case, the court said that neither the creation of the sell-back rights nor the payment to the taxpayer could be said to have occurred in relation to a CGT asset then owned by the taxpayer as the taxpayer’s ownership of the relevant shares at the time of the events was irrelevant to their occurrence. Options and withholding tax Law Companion Ruling LCR 2016/7 provides guidelines on withholding tax implications on the acquisitions of options to acquire TARP or indirect Australian real property interests, or acquisitions of TARP or indirect Australian real property interests as a result of exercising an option, under transactions entered into on or after 1 July 2016, where the vendor of the asset is a relevant foreign resident (¶2-280).

¶2-360 Special rules for trustees and beneficiaries of a trust The taxation of the beneficiaries and/or trustees of a trust under ITAA36 Div 6 is discussed in ¶1-505–¶1530. If the net income of a trust for an income year does not include a net capital gain or franked distribution, a beneficiary who is presently entitled to a share (ie a fraction or percentage) of the income of the trust (ie the distributable trust income as determined in accordance with trust principles and the trust deed) for the income year is taxed on that fraction or percentage of the net income of the trust for that income year as calculated for tax purposes. The trustee is taxed on any net income that is not attributed to a beneficiary in this way. If the net income of a trust for trust purposes includes a net capital gain or a franked distribution, the

capital gains or franked distribution that is reflected in the net income are taken outside the operation of Div 6 (by Div 6E) and are subject to the special rules in ITAA97 Subdiv 115-C (capital gains) and 207-B (franked distributions). These special rules enable the trustee to stream capital gains and franked distributions (where permitted by the trust deed) by making beneficiaries “specifically entitled” to an amount of a capital gain or franked distribution. To the extent that a capital gain or franked distribution is not attributed to a specifically entitled beneficiary, it is then attributed to the beneficiaries of the trust in accordance with their adjusted Div 6 percentages. A beneficiary’s adjusted Div 6 percentage is the percentage of the income of the trust (including capital gains that are treated as income and franked distributions) to which the beneficiary is presently entitled, adjusted to exclude any part of the capital gain or franked distribution to which any beneficiary is specifically entitled. Streaming capital gains to a beneficiary “specifically entitled” Where permitted by its trust deed, a trust may stream capital gains to particular beneficiaries who are considered to be “specifically entitled” to such capital gains provided the beneficiary receives, or can reasonably be expected to receive, an amount equal to the net financial benefit referable to that capital gain and the entitlement is recorded as such in the trust (s 115-228). A beneficiary can be reasonably expected to receive the net financial benefit from a capital gain even though the capital gain is not established until after year end (Taxation Determination TD 2012/11). However, a beneficiary cannot be made specifically entitled to a capital gain that is calculated using the market value substitution rule or that has been reduced to nil as a result of losses. The beneficiary’s fraction of the net financial benefit referable to a capital gain is reduced by trust losses or expenses applied to those gains (s 115-228(1)). Where a trustee makes a capital gain pursuant to CGT event E5 as a result of a beneficiary becoming absolutely entitled to an asset as a remainder beneficiary under a will, the beneficiary can be specifically entitled to the gain, as the financial benefit is the asset transferred and the will which created the trust recorded the absolute entitlement (Interpretative Decision ID 2013/33). The Commissioner has warned against using artificial capital gains tax streaming arrangements to create a mismatch between amounts beneficiaries are entitled to receive from a trust and the amounts they are taxed on (Taxpayer Alert TA 2013/1). Trustees should be aware of the tax consequences of distributing capital gains to non-resident beneficiaries. The Federal Court has held that the foreign resident exemption under ITAA97 s 855-10 (see “Foreign resident exemption — foreign trusts and beneficiaries” below) did not apply when foreign beneficiaries were specifically entitled to capital gains from an Australian resident trust; the trustee was therefore assessable on the capital gain. The Court said that trustee was not a foreign resident, so that s 855-10 did not apply. The section also did not apply to the foreign resident beneficiary as the distribution was not a capital gain “from” a CGT event, but a distribution of “amount” equal to the capital gain made by the trustee (Peter Greensill Family Co Pty Ltd (as trustee) v FC of T 2020 ATC ¶20-742, [2020] FCA 559). For a practitioner article, see “Trust gains of foreign residents” in Australian Tax Week (ATW ¶335, Issue 18, 2020). Capital gain remaining after streaming Any capital gain remaining after the specific entitlements have been determined will flow proportionately to the beneficiaries (and/or trustee) based on their share of the income of the trust, excluding the amounts to which beneficiaries/trustee are specifically entitled (this amount is known as the “adjusted Div 6 percentage” of the income of the trust estate for the relevant income year (s 115-227). Trustee is specifically entitled two months after the end of the income year A trustee can be made specifically entitled to an amount of a capital gain by choosing to be assessed on it, if permitted under its trust deed, and no trust property representing the capital gain is paid to or applied for the benefit of a beneficiary by the end of two months after the end of the income year (s 115-230). How to determine a beneficiary’s extra capital gain? Where a beneficiary has an entitlement to a capital gain made by the trust, whether due to a specific

entitlement or otherwise, the beneficiary is treated as having made an extra capital gain for CGT purposes using the process below: Step 1: Determine the beneficiary’s share of the capital gain of the trust, being the total of the capital gain to which the beneficiary is specifically entitled plus the beneficiary’s adjusted Div 6 percentage of capital gains to which no beneficiary is specifically entitled. Step 2: Determine the beneficiary’s fraction of the capital gain, by dividing the Step 1 amount by the total capital gain. Step 3: Determine the beneficiary’s “attributable gain”, by multiplying the fraction in Step 2 by the taxable income of the trust that relates to the capital gain if the total of the trust’s net capital gains and franked distributions (after being reduced by deductions directly relevant to them) is less than the trust’s net income (ignoring franking credits). If the trust’s net capital gains (as above) exceed the trust’s net income, the Step 3 attributable gain is proportionately reduced (s 115-225). Step 4: The extra capital gain for the beneficiary is determined based on the CGT concession applied by the trusts, by grossing-up the Step 3 amount as follows: • if either the CGT general discount (¶2-215) or the small business 50% reduction (¶2-337), but not both, applied to the capital gain — double the Step 3 amount • if both the general discount and the small business 50% reduction applied to the capital gain — quadruple the Step 3 amount • if no CGT discount or small business concessions applied —no grossing-up of the Step 3 amount (see the method statement in s 115-215(3)). The above process applies on a gain-by-gain basis for each capital gain of the trust. The Step 4 gross-up rules ensure that an eligible beneficiary is able to set off its current or prior year capital losses against the grossed-up capital gain as well as prevent the discount capital gain concession from flowing through to beneficiaries who are not entitled (eg sa company). Example The Better Trust (a discretionary trust) made a capital gain of $10,000 when it disposed of a CGT asset. The Trust applied the 50% CGT discount (small business relief is not available), resulting in a discounted capital gain of $5,000 for the year. The Trust has no capital losses or income losses. In accordance with the trust deed, the trustee of Better Trust resolved to distribute 50% of the gain from the sale of the asset to Abigail, a resident beneficiary, thereby making her specifically entitled to 50% of the capital gain. In the same year, the Better Trust also received $2,000 of net rental income, which it resolved to distribute to Abigail and ABG Pty Ltd in the ratio of 40% and 60%. Abigail Abigail’s extra capital gain (calculated using the four-step process) is as follows: 1. Share of the capital gain = $2,500 (being the specific entitlement) + $1,000 (being the adjusted Div 6 percentage of 40% of the balance of the capital gain) = $3,500 2. Beneficiary fraction = $3,500/$5,000 (being the capital gain) = 70% 3. Attributable gain = 70% × $5,000 = $3,500 4. Grossing-up for CGT discount applied = Step 3 amount ($3,500) × 2 = $7,000. Assume that Abigail has a $1,000 capital loss in the year she received the capital gain distribution from Better Trust. After offsetting her capital loss (−$1,000) to her extra capital gain ($7,000), Abigail applies the 50% discount resulting in a capital gain of $3,000 for the year. Note that Abigail will also have trust income of $800 for the year (being 40% of the $2,000 net rental income distributed). ABG Pty Ltd ABG’s additional capital gain is calculated as follows:

1. Share of the capital gain = $1,500 (being the adjusted Div 6 percentage of 60% of the capital gain remaining after specific entitlements excluded) 2. Beneficiary Fraction = $1,500/$5,000 (being the capital gain) = 30% 3. Attributable gain = 30% × $5,000 = $1,500 4. Grossing-up for CGT discount applied = Step 3 amount ($1,500) × 2 = $3,000. ABG Pty Ltd is a company and is not entitled to a CGT discount to its additional capital gain of $3,000. Note that ABG Pty Ltd will also have trust income of $1,200 for the year (being 60% of the $2,000 net rental income distributed).

Beneficiary entitled to a deduction A beneficiary is entitled to a deduction for the trust distribution amount that is attributable to the net capital gain of the trust so as to avoid double taxation. Example A fixed trust makes a capital gain of $1,000 when it disposes of a CGT asset. In calculating the net income of the trust, the trustee claims the 50% CGT discount resulting in a discounted capital gain of $500 (assuming that no small business relief is available). A company that is presently entitled to the net income of the trust is the sole beneficiary. The beneficiary company will gross up the discounted capital gain component to $1,000 and can apply capital losses against that $1,000 plus the $500 trust distribution. A company is not eligible to claim a CGT discount, so it must include the whole $1,500 in its assessable income for the year. The company is entitled to a $500 deduction, that being the relevant amount of the trust estate’s net capital gain. The effect for the company beneficiary is as follows.

$ Net trust income on which beneficiary is assessable

500

Discounted capital gain grossed-up (× 2)

1,000

Deduction for net trust income

(500) $1,000

This achieves the same result as if the beneficiary had made the net capital gain directly.

Foreign resident exemption — foreign trusts and beneficiaries A foreign resident or the trustee of a foreign trust for CGT purposes can disregard a capital gain or loss if a CGT event happens in relation to a CGT asset that is not TAP (¶2-280) (ITAA97 s 855-10(1)). In summary, where a CGT event happens to a non-TAP asset of a foreign trust: • the trustee can disregard any capital gain (or capital loss) from the event in calculating the net income of the trust under ITAA36 s 95(1), and • ITAA97 Subdiv 115-C does not treat the trust’s beneficiaries as having capital gains (or make the trustee assessable) in respect of the event (s 115-210(1)) (Taxation Determination TD 2017/23). However, if an amount attributable to the capital gain is paid or applied for the benefit of a beneficiary of the trust who is resident at any time during the income year in which the payment or application was made, the amount may be included in the beneficiary’s assessable income under ITAA36 s 99B(1) with certain exceptions (s 99B(2), 99C). Example Kiwi Trust, a foreign trust for CGT purposes, disposed of shares in Australian companies that are not TAP. No capital gains or losses from the disposal would be reflected in the net income of the trust under s 95(1) and the trust's beneficiaries (or the trustee) would not be treated as having made capital gains from the disposal under Subdiv 115-C. If Kiwi Trust were to distribute an amount attributable to the gain to a beneficiary resident in Australia, ITAA36 s 99B may then apply to include an amount in the beneficiary's assessable income.

An amount made assessable by s 99B(1) does not have the character of a capital gain for Australian tax purposes. Consequently, where an amount that is included in a beneficiary’s assessable income under s 99B(1) had its origins in a capital gain from a foreign trust’s non-TAP, the beneficiary cannot offset a capital loss or a carry-forward net capital loss (“capital loss offset”) or access the CGT discount in relation to the amount (Taxation Determination TD 2017/24). Example (from TD 2017/24) In June 2014, the trustee of a foreign trust for CGT purposes sells shares in an Australian public company that it had owned for five years. The trustee makes $50,000 capital gains in total. The shares are not TAP. In August 2016, the trustee distributes an amount attributable to the capital gains to Erin, a resident of Australia. Erin has a $40,000 net capital loss that she has carried forward from the 2013 income year. The capital gains are not taken into account in calculating the trust’s net income for the 2014 income year (ITAA97 s 855-10). Erin must include the entire $50,000 in her assessable income under ITAA36 s 99B. She cannot reduce the amount by her net capital loss or by the 50% CGT discount.

Foreign resident beneficiary exemption As noted above, if a trust's net income includes a net capital gain, s 115-215(3) treats a beneficiary as having extra capital gains which are included in the calculation of the beneficiary’s net capital gain under the method statement in s 102-5(1) (ie in addition to any gains that the beneficiary has made directly). Section 115-215(4A) makes it clear that the beneficiary is taken to have made these capital gains even though no CGT event has happened directly to the beneficiary. Section 855-40 disregards a capital gain that a foreign resident beneficiary of a fixed trust is taken to have made as a result of a CGT event happening to a CGT asset of that trust if, at the time of the event, the CGT asset was not TAP of the trust. The purpose of the provision is to provide comparable treatment to that which would have been available had the beneficiary directly owned the trust assets. The section also applies to disregard capital gains ultimately taken to be made by a foreign beneficiary through a chain of fixed trusts where the CGT event happens to a non-TAP CGT asset of the first-tier fixed trust. The ATO’s preliminary views are noted below: • Section 855-40 only disregards a capital gain that a foreign resident beneficiary makes because of s 115-215(3) if the trust is a fixed trust. • Section 855-10 (or s 768-915(1) for temporary residents) does not disregard a capital gain that a foreign resident (or temporary resident) beneficiary of a resident trust makes because of s 115-215(3) (Draft Taxation Determination TD 2019/D6). • A foreign resident beneficiary of a resident trust is assessable on non-TAP capital gains whether or not the gain has a source in Australia. The source concept in ITAA36 Pt III Div 6 is not relevant in determining whether an amount of trust capital gain is assessable to the non-resident beneficiary or trustee. The same view applies in relation to a non-resident beneficiary's share of TAP gains of a non-resident trust and a trustee's share of a capital gain to which ITAA97 s 115-222 applies. (Draft Taxation Determination TD 2019/D7).

STEP 4: ROLLING OVER/DEFERRING A CAPITAL GAIN OR LOSS ¶2-400 Deferring capital gains and losses In some situations you can defer a capital gain or loss which would otherwise arise when a CGT event occurs (eg when you dispose of an asset). This means that instead of CGT applying at that time, it is deferred until there is another CGT event affecting that asset, or its replacement. This deferral is called a rollover. Typically, rollovers are available where: • the disposal does not really involve any change in the underlying ownership of the asset, eg where an

asset is transferred from one group company to another, or from a partnership to a wholly owned company • the disposal has been forced on the person, eg where a person is forced to replace an asset which has been destroyed, or there is a split up of family assets on marriage breakdown, or • there are policy reasons, eg certain disposals of small business assets which are replaced. Generally, a rollover will mean that: • an asset which was pre-CGT retains its exempt pre-CGT status despite the disposal; however, this is not always the case (eg the rollover for small business assets) • the CGT liability of the person acquiring the asset is calculated as if that person had purchased the asset for an amount equal to the indexed cost base of the original owner. Some types of rollover are automatic (eg on marriage breakdown), but most require the taxpayer to make a specific choice for rollover to apply. This is important, because sometimes you may not wish to defer a capital gain or loss. For example, you may want to realise a loss so it can be offset against some other capital gain that you have derived. Or it may be preferable for a gain or loss to be attributed to the original owner rather than the person who acquired the asset. The general rules for making a choice are set out in s 103-25 of the ITAA97 (ID 2003/103: extension of time to make a choice where a taxpayer is unaware of availability of a concession). The more common circumstances of same asset and replacement asset rollovers are noted in ¶2-410.

¶2-410 Typical rollover situations There are two main types of rollovers — a replacement-asset rollover and a same-asset rollover (the main rollover relief provisions are noted below). A replacement-asset rollover involves a CGT event happening in relation to an asset, which the taxpayer no longer owns after the rollover. Instead, the taxpayer owns a different asset (ie the replacement asset) after the rollover. In such a case, any capital gain or loss arising from the CGT event which gave rise to the rollover is deferred until a later time when a CGT event happens to the replacement asset. The CGT characteristics of the original asset are transferred to the replacement asset. In the case of a replacement-asset rollover, any CGT liability remains with the taxpayer, even though that liability arises in relation to a different asset (some examples are listed below). A same-asset rollover involves a CGT event happening in relation to an asset which changes hands from one taxpayer to another, with the rollover attaching to the asset in the hands of the transferee. In such a case, any capital gain or loss from the CGT event arising in the hands of the transferor is ignored. Any capital gain or loss which later arises from another CGT event happening to the asset is only relevant for the transferee taxpayer. The CGT characteristics of the rolled over asset are transferred with the asset, from the transferor to the transferee. In the case of a same-asset rollover, any CGT liability is transferred from one taxpayer to another, though that liability attaches to the same asset (some examples are listed below). Same asset rollover ☐ transfer of a CGT asset to a wholly owned company (Subdiv 122-A; ID 2014/14: cost base of preCGT asset acquired) ☐ transfer of a CGT asset of a partnership to a wholly owned company (Subdiv 122-B) ☐ transfer of a CGT asset of a trust to a company under a trust restructure (Subdiv 124-N) ☐ marriage/relationship breakdown and asset transfers from one spouse to the other, or from a company or trust to a spouse (Subdiv 126-A: see below)

☐ transfer of a CGT asset between certain related companies (Subdiv 126-B) (ID 2012/56: legal merger of two companies of the same wholly owned group carried out under the law of a foreign country) ☐ CGT event happens because a trust deed of a complying approved deposit fund, a complying superannuation fund or a fund that accepts worker entitlement contributions is changed (Subdiv 126C) ☐ splitting superannuation interests in a marriage/relationship breakdown — transfers of assets from one small superannuation fund to another complying superannuation fund (Subdiv 126-D) ☐ beneficiary becomes absolutely entitled to a share following a scrip for scrip rollover (Subdiv 126-E) ☐ when assets are transferred between fixed trusts which have the same beneficiaries with the same entitlements and no material discretionary elements (Subdiv 126-G) (Taxpayer Alert TA 2019/2: ¶2650 ☐ where an interest holder exchanges shares in a company or units in a unit trust for shares in another company as part of a restructure (Div 615) ☐ transfers of assets as part of a change of legal structure without a change in the ultimate legal ownership (Subdiv 328-G) (see “Small business restructure rollover” below). Replacement asset rollover ☐ disposal or creation of asset(s) of a business to a wholly owned company by an individual, or a trustee or a partner (Subdiv 122-A and 122-B) ☐ asset compulsorily acquired, lost or destroyed (ie involuntary disposal of asset) (Subdiv 124-B) ☐ renewal or extension of a statutory licence (Subdiv 124-C) ☐ strata title conversions (Subdiv 124-D) ☐ exchange of shares in the same company or of units in the same unit trust (Subdiv 124-E) ☐ exchange of rights or options to acquire shares in a company (ie share splits or consolidations) or to acquire units in a unit trust (ie unit splits or consolidations) (Subdiv 124-F) ☐ exchange of shares in one company for shares in an interposed company (Subdiv 124-G) ☐ exchange of units in a unit trust for shares in a company (Subdiv 124-H) ☐ rollover for change of incorporation (Subdiv 124-I) ☐ renewal or extension of Crown lease or conversion of Crown lease to freehold (Subdiv 124-J) ☐ rollover for depreciable plant (Subdiv 124-K) ☐ renewal or extension of prospecting or mining right, or conversion of prospecting right to mining right (Subdiv 124-L) ☐ scrip for scrip rollover (Subdiv 124-M) ☐ Medical defence organisation (MDO) interest exchange rollover (Subdiv 124-P) ☐ trust restructuring and transfers of assets to company in exchange for shares (Subdiv 124-N) ☐ reorganisation of stapled entities (Subdiv 124-Q)

☐ securities lending arrangements (ITAA36 s 26BC) ☐ demergers rollover relief (Div 125). Rollover relief in special situations and transitional relief ☐ death of the primary owner of CGT assets (s 128-10; see Chapter 19) ☐ rollover relief for transfers of assets when superannuation funds merge (not applicable to SMSFs) as part of the MySuper products reforms (Div 310) ☐ rollover relief for a mandatory transfer of a member’s superannuation interest to a MySuper product in another superannuation fund or within the same superannuation fund, as part of the MySuper reforms (Div 311) ☐ transitional CGT relief for superannuation funds (so as to comply with the transfer balance cap requirements and the exclusion of transition to retirement income streams (TRIS) from being superannuation income streams in the retirement phase from 1 July 2017) (ITTPA Subdiv 294-B) (Law Companion Ruling LCR 2016/8). Rollovers — foreign interest holders in a restructure Some CGT rollovers for entity restructures require that all of the interest holders must exchange their interests in the original entity for interests in the new entity and that each interest holder owns the same, or substantially the same, percentage of interests in the new entity as previously owned in the original entity (see, for example, the “same ownership requirements” in Subdiv 124-G, 124-H, 124-I, 124-N, 124Q and 126-G, and Div 125). Where a share sale facility is used to deal with the interests of a foreign interest holder, the same ownership requirements generally cannot be satisfied as the interests are now owned by the share sale facility and not the foreign interest holder. Entities in a restructure can use a share or interest sale facility to deal with foreign held interests. This is achieved by treating a foreign interest holder as owning the relevant interest in an entity at a time the share sale facility owns the interest in that entity for the purposes of the relevant CGT entity restructure rollover provisions. Compulsory acquisition rollovers If a CGT asset owned by you is compulsorily acquired, you may choose a CGT rollover with the effect that a capital gain that would otherwise be recognised when the transfer of the asset occurs is disregarded, and recognition of the accrued capital gain is deferred until there is a later disposal of (or other CGT event happens to) the asset. The compulsory acquisitions rollover also preserves the pre-CGT exempt status of replacement assets if the original asset had that status. Compulsory rollover relief is available if the asset: • is compulsorily acquired by an Australian government agency (ie by the Commonwealth, a state or a territory or by an authority of the Commonwealth, a state or a territory) • is wholly or partly lost or destroyed, or • is an expired lease that is not renewed. You will also be able to choose a CGT rollover and/or a balancing adjustment offset in the following circumstances: • when the asset is disposed of to a private acquirer who has recourse to compulsory acquisition under a statutory power other than a compulsory acquisition of minority interests under company law, and • when land (and any depreciating asset fixed to the land), which was compulsorily subject to a mining lease, is disposed of to the lessee.

Small business asset rollovers A small business taxpayer can obtain CGT rollover relief on the disposal and replacement of some or all of its active assets where certain conditions are met (see ¶2-339). Example James owns 50% of the shares in ABCco and XYZco, ie he is a significant individual of both companies. The companies are also connected with James because he controls them. ABCco owns land which it leases to James for use in a business. It sells the land at a profit and buys shares in XYZco. The replacement asset test is satisfied because James is connected with ABCco and is a significant individual of XYZco.

Rollover relief when trusts are restructured Optional CGT rollover relief is available to facilitate trust restructuring arrangements. This applies where: • a trust disposes of all of its assets to a company on or after 11 November 1999 • the beneficiaries’ interests in the trust are exchanged for shares in the company in the same proportion as they owned interests in the trust. Rollover relief is available for both the trust and its beneficiaries, but not to discretionary trusts. If the trust does not cease to exist within six months from the time of transferring the assets, the benefit of the rollover is reversed (CGT event J4: ¶2-110) unless the failure to transfer the assets is outside the control of the trustee. Small business restructure rollover Optional rollover relief is available for the transfer of assets as part of a change of legal structure without a change in the ultimate legal ownership of the assets (ITAA97 Subdiv 328-G). To qualify, the conditions in s 328-430 must be met — namely, there is a “genuine restructure” (Law Companion Ruling LCR 2016/3 explains what is “genuine restructure”), the parties to transaction are eligible entities, ultimate economic ownership of the assets is maintained, the transferred asset is an eligible asset that satisfies the active asset test, the parties satisfy the residency requirement and a choice is made for the rollover relief. The assets covered by the rollover relief are CGT assets, trading stock, revenue assets and depreciating assets (s 328-455; 40-340) (Law Companion Ruling LCR 2016/2 provides examples of rollover). The rollover relief provides for tax neutrality so that there will be no direct income tax consequences arising from the transfer of asset pursuant to the rollover, including the potential application of Div 7A where the transfer may otherwise be treated as a deemed dividend (see s 328-450 and example). Depreciating assets transferred under Subdiv 328-G will not result in a balancing adjustment, typically in restructures where the trustees of trusts transfer depreciating assets to beneficiaries, or by companies to shareholders (Taxation Administration (Remedial power — Small Business Restructure Rollover) Determination 2017) (/F2017L01687). Marriage/relationship breakdown rollovers Marriage or relationship breakdown rollover relief is available if certain CGT events happen (involving an individual and his/her spouse, or involving a company or trustee and an individual’s spouse or former spouse) because of: • an order of a court under the Family Law Act 1975 (or a corresponding foreign law) • a maintenance agreement approved by a court under the family law (or a corresponding agreement under a foreign law), or • a court order made under a state or territory law relating to the breakdown of de facto marriages (eg the Property (Relationships) Act 1984 (NSW) or the Property Law Act 1958 (Vic)).

The CGT events that are relevant to marriage breakdown rollover relief are of two types — disposal cases (CGT events A1 and B1) and creation cases (CGT events D1, D2, D3 and F1). CGT rollover relief is also available for assets transferred to a spouse or former spouse under a binding financial agreement or arbitral award under the family law, or a written agreement under a state, territory or foreign law relating to de facto marriage breakdowns where the agreement is similar to a binding financial agreement. This will allow spouses to settle property issues without involving the courts, thus avoiding potential costly and protracted litigation. The Full Federal Court has held that a taxpayer was not entitled to CGT marriage breakdown rollover relief for the transfer of shares made at the instance of the husband, allegedly in accordance with directions given by his former wife and pursuant to orders of the Family Court (Ellison & Anor v Sandini Pty Ltd & Ors; FC of T v Sandini Pty Ltd & Ors 2018 ATC ¶20-651). For a practitioner article, see “CGT marriage breakdown rollover — the Sandini case revisited” by Andrew Henshaw, in CCH Tax Week ¶256 (2018). Marriage breakdown financial planning issues are discussed in detail at ¶12-200 and in Chapter 18. Scrip for scrip rollover relief Scrip for scrip rollover relief is available when interests held by a taxpayer in one entity are exchanged for replacement interests in another entity, typically as a result of a takeover offer or merger. In FC of T v Fabig 2013 ATC ¶20-413, the court when determining whether an exchange is made as a consequence of a single arrangement requirement held that relief was not available on the sale of the taxpayers’ shares in one company for shares in another company because they did not satisfy the requirement in ITAA97 s 124-780(2)(c) that participation in the sale was available on substantially the same terms for all shareholders (see also ATO Decision Impact Statement Ref No: NSD 247 of 2013). The rollover only applies when the exchange would otherwise result in a capital gain, ie if a capital loss would arise, there is no rollover. Where the rollover applies, the capital gain arising from the exchange of the original asset is disregarded. The amount included in the first element (acquisition cost) of the cost base of the replacement interest is calculated on the basis of a reasonable apportionment of the cost base of the original asset. The reduced cost base is worked out on a similar basis. An exchange of interests must arise under an arrangement in which all owners of voting shares in the original entity (apart from the acquiring company) can participate on substantially the same terms. It is not necessary that the acquiring company have any shares in the original company before launching a takeover bid (TD 2000/51). For a case which examined whether pre-contractual offers could form a single arrangement thus allowing a share exchange to qualify for scrip for scrip rollover, see Dickinson v FC of T 2013 ATC ¶20-413. In the case of a trust, the arrangement must be from a fixed trust and for the acquisition of trust voting interests or, if there are none, for units or other fixed interests in the trust. This can include the exchange of an interest (not being a unit) in a trust for a unit in a unit trust (TD 2002/22). Certain tax avoidance schemes connected with scrip for scrip rollover, in particular an arrangement in which taxpayers seek to use the rollover to obtain the benefit of a capital gain without paying CGT, are examined in Taxation Ruling TR 2005/19.

STEP 5: CALCULATING THE TAX ¶2-500 Net capital gains and losses Capital gains and losses are calculated separately for each CGT event that occurred during the tax year. Assuming that the capital gain or loss is not exempt and is not being rolled over, the next step is to work out the tax liability. A taxpayer’s assessable income includes any net capital gain made for the income year. The net capital gain is worked using the Steps below (ITAA97 s 102-5): Step 1: Capital gains made during the income year are reduced by capital losses made during the income year. You can choose the order in which the capital gains are reduced (see “Applying capital losses” below), subject to some specific rules which permit or require you to disregard certain capital gains or losses when working out net capital gain.

Step 2: If the capital gains are more than the capital losses, the difference is then reduced by any unapplied net capital losses carried forward from earlier income years. Again, you can choose the order in which the capital gains are reduced. Step 3: Each amount of a discount capital gain remaining after Step 2 is reduced by the relevant discount percentage (¶2-215). Step 4: If any of the taxpayer’s capital gains (whether or not they are discount capital gains) qualify for any of the small business concessions (¶2-300), those concessions, as appropriate, are applied to each capital gain. Step 5: The sum of the amounts of capital gains remaining after Step 4 will be your net capital gain for the income year. Capital losses If your capital losses in an income year exceed your capital gains in that year, you have a “net capital loss” for the income year (ITAA97 s 102-10). That amount is not deducted against other assessable income which you may have in the income year. However, it can be carried forward without a time limit so that it can be offset against any capital gains which may be realised in subsequent years. Therefore, to the extent that a net capital loss cannot be used to offset capital gains in an income year, it can be carried forward to a later income year. For 1996/97 and later income years, net capital losses attach to the year in which they were made. Unrecouped losses for income years up to 1995/96 attach to the 1995/96 income year. Example During the tax year, Laurence realised capital gains of $120,000 and capital losses of $90,000. Laurence therefore has a net capital gain of $30,000 for the year, which is added to his other assessable income for that year. If instead Laurence had realised capital gains of $25,000 and capital losses of $60,000, he would have a net capital loss of $35,000 for the year. This can be carried forward and offset against capital gains realised in later years. Applying other exemptions Certain CGT events require a taxpayer to disregard a capital gain or loss (eg if CGT event A1 happens to a CGT asset acquired by the taxpayer before 20 September 1985). In other cases, exemptions may apply to reduce or disregard the capital gain or loss. In calculating the capital gain that is subject to the discount (Step 3), the taxpayer takes these general exemptions into account before offsetting any available capital losses and applying the CGT discount.

Example Rohan bought some shares for $50,000 in earlier years which he sold in the current year for $75,000. Rohan has prior year net capital losses of $4,000, as well as a current year capital loss of $6,000 from other asset sales, and he chooses to apply the than to index the cost base. Shares:

$  Capital proceeds:

75,000

Less: cost base

50,000

Capital gain

25,000

Rohan will then apply his capital losses as follows:

Capital gain

25,000

Less: current year loss

6,000

Less: prior year losses

 4,000

Capital loss

15,000

Rohan can then apply the CGT discount to calculate his net capital gain:

Capital loss

15,000 × 50%

Net capital gain

 7,500

Applying capital losses A taxpayer may choose to apply capital losses against capital gains in any order. In most cases, the best outcome will be achieved if capital losses are applied against capital gains in the following order: (1) to capital gains that are not entitled to receive any indexation of the cost base, or any CGT discount (eg assets owned for less than 12 months or assets acquired by companies after 30 June 1999), or any benefit of the CGT small business concessions (2) to capital gains calculated with the asset’s indexed cost base (3) to discount capital gains that are not eligible for the CGT small business concessions (4) to capital gains that are eligible for the CGT small business concessions but are not discount capital gains (5) to discount capital gains that are eligible for the CGT small business concessions. If you choose to claim the frozen indexation option, capital losses will be applied against the capital gain arising after deducting the cost base, including any indexed elements, from the capital proceeds. If the indexation option is not chosen, or it is not available, the capital gain is calculated by deducting the nonindexed cost base from the capital proceeds. Capital losses are applied against the capital gain before it is reduced by the CGT discount. Previous years’ net capital losses Net capital losses from previous income years must be applied in the order in which they were made. Subject to this rule, you can choose to apply any prior year net capital losses against capital gains for the income year in any order. Any prior year net capital losses will be applied against the current year capital gains before applying the CGT discount (Step 2 above). If a capital gain remains after applying all available capital losses, the remaining capital gain is reduced by the appropriate CGT discount (if available) (Step 3 above). If any of the capital gains qualify for small business concessions, those concessions are then applied against each qualifying capital gain (Step 4 above). The remaining amount is the taxpayer’s net capital gain for the year. Example Adam acquired shares in a listed public company in June 2018 and units in a listed unit trust in May 2019. Adam has a carried forward net capital loss of $12,000 from the 2019/20 income year and incurred a further capital loss of $6,000 in 2020/21. In September 2020, Adam sells the shares and makes a capital gain of $4,000. In February 2021, he sells the units and makes a capital gain of $22,000. Adam may choose to apply his capital losses in any order, but he must apply his current and prior year losses against discount gains before reducing them by the discount percentage. He decides to apply the $6,000 current year loss first against the $4,000 gain realised in September 2020. The remaining $2,000 current year loss balance and the prior year net capital loss of $12,000 are applied against the discount gain of $22,000, resulting in a nominal gain after losses of $8,000. The nominal gain is reduced by the CGT discount (50% for individuals), leaving a net capital gain of $4,000 to be included in assessable income for 2020/21.

¶2-520 Overlap with other tax rules and avoidance schemes It is possible that the same transaction can be caught by the ordinary tax rules as well as the CGT rules.

In these cases, the ordinary tax rules take priority — any amount that is assessed under the ordinary tax rules will reduce the amount of capital gain. This is intended to avoid a taxpayer being taxed twice on the same gain. Often the amount assessable under the ordinary tax rules is bigger than the amount assessed under the CGT rules. This will typically be because the CGT rules allow for the cost of the asset to be indexed in certain circumstances, so reducing the capital gain. In the case of a business’s trading stock, capital gains and losses are generally disregarded (¶2-270) and the tax position is governed entirely by the ordinary trading stock provisions in the ITAA97. GST and input tax credits are generally disregarded in CGT calculations. For example, this means that the cost base of an asset does not include amounts corresponding to input tax credits to which the taxpayer is entitled, and the capital proceeds do not include any GST component of the consideration. Benefits under employee share schemes are taxed under special rules in the ITAA97, with special CGT rules to ensure that there is no double taxation (¶2-205). Foreign capital gains and foreign income tax offset Double taxation relief is available if a resident derives capital gains from sources outside Australia and the gains are subject to tax in the other country. Also, a foreign income tax offset (FITO) provides relief from double taxation by allowing a taxpayer to claim a FITO for any foreign tax paid on amounts included in the taxpayer’s assessable income (ITAA97 s 770-75(4): ¶1-575). The ATO’s provisional view is that capital gains are not included under s 770-75(4)(a)(ii) when calculating the FITO limit (Draft Determination TD 2019/D10). If a taxpayer makes a capital gain in respect of which the taxpayer has not paid foreign income tax, no amount of that capital gain would be included in s 770-75(4)(a)(i). Under s 770-75(4)(a)(ii), an amount is included if it is “ordinary income” or “statutory income” from a source other than an “Australian source”. A net capital gain, rather than each capital gain, is an amount of statutory income. A net capital gain does not have a source, because it is a product of capital gains and losses made during the income year from Australian and non-Australian sources, the application of unapplied net capital loss from earlier income years and applicable discounts. Accordingly, s 770-75(4)(a)(ii) does not allow taxpayers to disaggregate a net capital gain (the singular amount of “statutory income”) to identify capital gains that have been included in working out the net capital gain. The Full Federal Court has held that where the 50% discount is applied to a foreign capital gain only 50% of the foreign tax paid on the gain is available (Burton v FC of T 2019 ATC ¶20-709, [2019] FCAFC 141). In that case, the taxpayer claimed FITOs in his Australian tax returns in respect of US-sourced gains that were equal to the whole of the assessed US income tax that he had paid. The ATO reduced those FITOs to amounts equal to the US income tax paid in respect of the amount of the gains which were included in the taxpayer's assessable income in Australia, consistent with the ATO's view in ID 2010/175 Foreign income tax offset: entitlement where foreign capital gain is only partly assessable in Australia (the High Court has refused special leave to appeal; see also ATO’s Decision Impact Statement). Avoidance schemes When considering the effectiveness of any plan or arrangement to minimise the effect of CGT, a taxpayer and/or tax planner or adviser should bear in mind the possible application of any specific provisions of an anti-avoidance nature in the CGT provisions themselves, as well as the possible operation of the general anti-avoidance provisions in Pt IVA of the ITAA36. The ATO has issued many taxpayer alerts on avoidance schemes which may have CGT consequences (available at law.ato.gov.au/).

¶2-530 Keeping records: asset registers You must keep records of every act, transaction, event or circumstance that may be relevant to working out whether you have made a capital gain or capital loss from a CGT event happening. The records must be in English (or be readily accessible in or translatable to English) and must show:

• the date the asset was acquired, its cost or market value • the date the asset was disposed (or CGT event happening), and the proceeds received or market value of asset • costs associated with acquiring and selling the asset, such as stamp duty, commissions, advertising and legal fees, interest, fees paid to agents and accountants • costs associated with holding the asset that are not tax deductible, including improvements, rates, land tax, insurance, repairs and interest on money borrowed to acquire the asset • indexation adjustments (where relevant for assets acquired before 21 September 1999: ¶2-210) • particulars of the people, businesses or organisations involved in the transaction • market valuations, if required, and • records from the previous owner, particularly if the asset was inherited. Examples of the types of records you may need to keep include receipts for the expenditures incurred, including whether a tax deduction has been claimed for an item of expenditure. Accurate records are particularly essential, for example, in keeping track of share transactions, bonus share issues and shares acquired under dividend reinvestment schemes, and assets that are inherited. Your CGT records must be kept for five years after the last relevant CGT event occurs. (Typically this means five years after the asset is disposed of.) You do not have to keep records if the transaction is exempt from CGT. If you wish, you can transfer the information from these records to a CGT asset register that is certified by a tax agent or other authorised person. Entries in this register have to be kept for the usual five-year period after the relevant CGT event occurs. However, the source documents relating to the entry need only be kept for five years after the entry is made. Tax loss records You should also keep records relating to a net capital loss for an income year which you may be able to apply against a capital gain in a later year. The records relevant to the ascertainment of that loss must be kept for longer than the record retention period prescribed under income tax law. In particular, the records must be kept until the later of: • the end of the statutory record retention period, and • the end of the statutory period of review for an assessment for the year of income when the tax loss is fully deducted or the net capital loss is fully applied. There is no time limit on how long you can carry forward a net capital loss, but you will need to keep your records for five years after you have claimed the last of it. For example, if you carry forward a net capital loss for 15 years before it is all claimed, you will need to keep your records for 20 years (ie from when you incurred the original net capital loss to five years after you claimed the last of it). Also, where a formal dispute arises in relation to a loss, the records must be retained until any objection or appeal in relation to the loss is finally determined. The ATO’s CGT record-keeping tool is available at www.ato.gov.au/calculators-and-tools/capital-gains-tax-record-keeping-tool.

Caution Good record-keeping is generally essential for various reasons: • it makes good business sense

• to be able to work out CGT liabilities for transactions which may have occurred some time in the past • to identify the costs which comprise the cost base or reduced cost base • in case they are needed in an ATO review or audit.

SUMMARY — CHECKLISTS ¶2-600 CGT planning checklist The special rules applying to CGT can open up some planning possibilities. You should adopt a logical and methodical approach to CGT issues, applying a step-by-step approach that ensures all relevant aspects that may relate to a CGT transaction are properly considered. Here are some to keep in mind (see also “Taxpayer alerts” at ¶2-650 and the CGT topical checklist at ¶2-700).

Checklist ☐ Maximise the cost base ☐ Do the calculations for each asset disposed of to ascertain whether to choose the CGT discount or frozen indexation option when calculating capital gains (the frozen indexation option is not available for assets purchased after 20 September 1999: ¶2-215) ☐ Ensure that capital losses are utilised ☐ Examine the availability of, and use exemptions and concessions ☐ Examine the availability of, and use, rollovers to best advantage ☐ Keep tax in perspective

Maximise the cost base The higher the cost base, the lower the assessable capital gain. In maximising the cost base, remember that: • if you purchase by instalments, the whole amount of those instalments is taken into account in calculating the cost base • capital enhancements can form part of the cost base — the purpose or effect expenses must be to increase or preserve the asset’s value, or relate to installing or removing the asset • you may need to take care in situations where the cost base has been reduced (¶2-205) • you should ascertain whether the CGT discount or frozen cost base option is more beneficial for each asset that is disposed of (¶2-215) • records of eligible expenditure should be kept (¶2-200, ¶2-530). CGT events and timing

Where more than one CGT event can apply to a situation, carefully consider the implications: • look at the rules for each of the potentially applicable events to determine the three key factors — timing, calculation of gains/losses, and concessional rules (for a list of CGT events, see ¶2-110) • if more than one event could potentially apply, seek to ensure that the most specific event will be the one that is most advantageous in terms of the key factors • on timing of CGT events, postpone triggering events likely to give rise to capital gains occurring at or shortly before the end of the income year in order to maximise the period of grace before the tax liability arises. Selling or holding on to assets The time when you buy and sell an asset can make a big difference to the CGT liability, for example: • selling an inherited family home within two years of inheritance should be considered as the property will keep its main residence exemption for this period (¶19-605) • to be eligible for the CGT discount, assets must be owned for at least 12 months, with some exceptions where a rollover is involved (¶2-215) • before selling a pre-CGT home, consider renting it out and buying a new residence for owner occupation, or • the capital gain on a disposal is assessable in the year of disposal, so deferring the disposal can defer the tax to that year. This can be particularly beneficial if that year is a low income year. Ensure that capital losses are utilised Capital losses can only be offset against current or future capital gains, so: • depending on your circumstances, it may be a good idea to bring forward a disposal so as to realise an inevitable capital loss which can be offset against gains in that year • be aware that a person’s capital losses will generally be lost when the person dies. Use exemptions and concessions Examine all the possible exemptions and concessions that may be available: • some assets are exempt in all circumstances (eg cars). Others are only exempt if they are not resold (eg pre-CGT assets), so think carefully before realising appreciating pre-CGT assets. Others are exempt only if they are used in particular ways (eg main residence) or if the taxpayer satisfies special conditions (eg the rules for the small business concessions) • some exemptions automatically apply when all the conditions for it are satisfied (eg the main residence exemption: ¶12-000ff), and you cannot choose that the exemption does not apply • be aware too that seemingly innocuous events, such as a change in partnership interests (¶2-220), or a change in the underlying interests in a company or trust (¶2-260), can have the effect of destroying the exempt pre-CGT status of an asset. If an exempt asset and a taxable asset are sold together for an overall price, care should be taken not to undervalue the exempt asset • exercise care so that a change in circumstances or change in use of a replacement asset will not trigger CGT event J2, J5 or J6 which will result in a reversal of the rollover concession and in the crystallisation of a previously deferred capital gain (¶2-339) • maximise your main residence exemption by purchasing an adjoining block (and building a tennis court, for example), as the family home is exempt from CGT along with any surrounding land not exceeding two hectares.

Use rollovers to best advantage Rollovers can be a useful way to preserve the exempt pre-CGT status of assets, or to defer the realisation of a capital gain. However, rollovers may not be appropriate if, for example, you wish to realise a capital loss on the asset, or if the transferee is a higher-rate taxpayer. You need to check in each case whether the rollover is automatic or optional (ie you must make a choice for the rollover to apply) and the exact consequences, as these may vary. Keep tax in perspective CGT, ordinary tax and other taxes such as stamp duty are only part of the picture. In any transaction, non-tax factors — including commercial considerations, cash flow, market conditions and the taxpayer’s personal situation — obviously must be taken into account. The fact that one course of action has the best tax result does not necessarily mean that it is the best course to take, or even that it should be taken at all.

¶2-650 Taxpayer alerts From time to time, the ATO issues Taxpayer Alerts which set out the areas of concern involving significant new tax planning issues and arrangements under examination where the ATO has not yet come to a concluded view. Financial and tax advisers should bear in mind that the ATO may not agree with the tax benefits being claimed with respect to a particular arrangement. Taxpayer Alerts cover a diverse range of concerns across CGT and other taxes as well as related regulatory issues and they should be carefully considered in all cases when planning commercial and personal transactions. Alerts with particular relevance to CGT planning include the following: • arrangements to exploit mismatches between trust and taxable income (TA 2013/1: see below) • purported alienation of income through discretionary trust partners (TA 2013/3: see below) • arrangements using a trust structure to ensure that, on the sale of the CGT assets to an arm’s length party, the taxable capital gains are streamed to a tax-preferred entity (such as a charity) while the original asset owners receive the sale proceeds free of CGT liability (TA 2003/3: see below) • profit washing schemes involving a trust and loss entity by using tax losses in an unrelated entity (wash sales) and restructuring a business so that the business income passes through a chain of trusts to a loss company (TA 2005/1) (see also Taxation Determination TD 2005/34, Taxation Ruling TR 2008/1) • stapled securities arrangements where an Australian resident public company issues a stapled security made up of a note and a preference share to resident investors (TA 2008/1) • borrowing arrangements, and non-arm’s length arrangements under which a SMSF derives income through a direct or indirect interest in a closely held trust (TA 2008/3, TA 2008/4) • profit washing scheme using a trust and a loss entity similar to those covered by TA 2005/1 (TA 2008/15) • foreign residents attempting to avoid Australian CGT by certain “staggered sell-down” arrangements (TA 2008/19) • foreign residents exploiting asset valuations to avoid CGT (TA 2008/20) • individual shareholders re-characterising capital losses as revenue losses (TA 2009/12: see below) • artificially creating capital losses through default beneficiary arrangement to offset capital gains (TA 2009/14: see below)

• circumvention of in-house asset rules by SMSFs using related party agreements (joint ventures) (TA 2009/16) • buying insurance bonds issued from tax haven entities (TA 2009/17) • discretionary option arrangements (TA 2009/18) • non-market value acquisition of shares or share options by an SMSF (TA 2010/3) • non-disclosure of foreign source income by Australian tax residents (taxable capital gains may arise to the taxpayer on the disposal of offshore assets) (TA 2012/1) • accessing private company profits through a dividend access share arrangement attempting to circumvent taxation laws (a taxing event may generate a capital gain under CGT event K8 for the original shareholders of the target company by virtue of the ITAA97 Div 725 direct value shifting rules) (TA 2012/4) • deduction generation from purported purchase of offshore “emission units” that do not exist at the time of the arrangement (the grant, exercise and/or end of the put option results in a CGT event happening and a capital gain or loss for the grantor and/or participant; a capital gain (eg CGT event K1 happening) from the delivery of the units, or the transfer or holding of the units in the participant’s registry account) (TA 2012/6) • SMSFs and limited recourse borrowing arrangements to acquire property (unit trust may incur a CGT liability for the disposal of the property, and the members and SMSF may be required to include a capital gain in their assessable income an amount on redemption of their units in the unit trust) (TA 2012/7) • arrangements to exploit mismatches between trust and taxable income (TA 2013/1: see below) • purported alienation of income through discretionary trust partners (TA 2013/3: see below) • trusts mischaracterising property development receipts as capital gains (TA 2014/1) • dividend stripping arrangements involving the transfer of private company shares to a self managed superannuation fund (TA 2015/1) • arrangements that purportedly allow a unit trust to effectively dispose of a CGT asset to an arm's length purchaser with no CGT consequences so as to exploit the CGT rollover for trust restructures provided by Subdiv 126-G (TA 2019/2: see below) • arrangements where a taxpayer with a current or future capital gain attempts to artificially create an offsetting capital loss by becoming a default beneficiary for a discretionary trust (for no consideration) and then transferring their interest in that trust (for no consideration) (Taxpayer Alert TA 2019/14: see below) • international arrangements that mischaracterise Australian activities connected with the development, enhancement, maintenance, protection and exploitation (DEMPE) of intangible assets. These arrangements may be non-arm's length or structured to avoid tax obligations, resulting in inappropriate outcomes for Australian tax purposes and may fail to properly comply with Australian income tax obligations such as the CGT and capital allowances provisions (Taxpayer Alert TA 2020/1). Advisers and taxpayers should also be mindful that certain transactions may trigger a specific antiavoidance or the general anti-avoidance provisions (see ¶1-600) or may be a tax exploitation scheme for the purposes of Div 290 of Sch 1 to the Taxation Administration Act 1953. Penalties under the income tax laws are discussed in ¶1-750.

Arrangements to exploit mismatches between trust and taxable income Taxpayer Alert TA 2013/1 warns about artificial arrangements where a deliberate mismatch is created between the amounts beneficiaries are entitled to receive from a trust and the amounts they are taxed on. The arrangement concerns a situation where a trust has generated a small amount of income and a large capital gain during the year. The trust distributions are made in such a way that one beneficiary receives the funds generated from the capital gain, tax free, while another beneficiary (a new incorporated company) receives the tax liability attached to that capital gain. The newly incorporated company receives no funds from the capital gain to pay this tax liability, and winding-up proceedings are commenced. This process is designed to avoid the payment of tax on the large taxable capital gain. Purported alienation of income through discretionary trust partners Taxpayer Alert TA 2013/3 warns about arrangements where an individual purports to make the trustee of a discretionary trust a partner in a firm of accountants, lawyers or other professionals (firm), but fails to give legal effect to that structure or fails to account for its tax consequences. For example, an individual purports to alienate income attributable to his/her professional services to a trustee partner, so that income that would otherwise be assessable to the individual is the income of a different entity. This may occur as the result of the assignment of an existing partnership interest, or by the creation of a new interest. The ATO’s concerns include: whether the transactions are legally effective; whether any transactions intended to make the trustee a partner in the firm give rise to or increase a net capital gain for the individual in the year of income (such as whether a CGT event has happened to an interest held by the individual in a partnership, what capital proceeds are associated with the event, and whether the individual’s net capital gain is reduced by the CGT discount or small business concessions in ITAA97 Div 152, and whether the general anti-avoidance rules in Pt IVA of the ITAA36 apply to cancel tax benefits obtained by the individual. CGT avoidance using a trust structure Taxpayer Alert TA 2003/3 warns about CGT avoidance arrangements using a trust structure which seek to ensure that, on the sale of CGT assets to an arm’s length party, the taxable capital gains are streamed to a tax-preferred entity (such as a charity) while the original owners of the assets receive the sale proceeds free of any CGT liability. These arrangements have the following features: (1) Assets owned by an individual or under a partnership or trust structure are disposed of to a special purpose company (SPC) and rollover relief is claimed under Div 122. (2) A “bare” trust (First Trust) is created over the SPC assets with the sole beneficiary of the trust being the SPC. The trust deed allows further beneficiaries to be appointed with the consent of the original beneficiary. First Trust is a discretionary trust but is referred to as a hybrid or convertible trust. (3) SPC consents to the trustee appointing new beneficiaries of the First Trust which are trustees of other trusts and may be associates of the promoter of the arrangement. (4) A second trust is created (Second Trust) of which the beneficiaries are the original owners of the assets. The assets are then sold to this Second Trust for a nominal amount. However, the promoter argues that this sale for CGT purposes is deemed to have occurred at market value. This means that the First Trust has a deemed capital gain and the Second Trust acquires the assets with a market value cost base. (5) The Second Trust sells the assets for market value to a third party purchaser. (6) The Second Trust claims to have no taxable capital gain and distributes the sale proceeds (after deducting the promoter’s fees) to the original owners in an arguably tax-free manner, eg as a loan or capital distribution. (7) The First Trust returns the deemed assessable capital gain and distributes this to the newly appointed beneficiaries which, in turn, distribute this income to a beneficiary which has significant

capital losses or is tax exempt, such as a charity. No funds are actually received by the charity or other beneficiary. Shareholders re-characterising capital losses as revenue losses The ATO has warned about arrangements where taxpayers seek to re-characterise their shareholding status from a long-term capital investor to a trader in shares (Taxpayer Alert TA 2009/12). The taxpayers involved would have claimed the CGT discount on previous receipts, but are now realising losses which they seek to claim as tax deductions against ordinary income (as opposed to capital losses which can only be offset against capital gains). These arrangements have features that are substantially equivalent to the following: (1) The taxpayer is an individual investor who holds shares. (2) The taxpayer has previously disposed of shares realising a profit, and treated that profit as a capital gain. This is done on the basis that the shares were held with the intention of benefiting from a long-term increase in capital value and/or the receipt of dividend income during the holding period. The taxpayer’s records are maintained on this basis. (3) As the taxpayer is an individual and had held the shares for more than 12 months, the taxpayer claimed the 50% CGT discount in their income tax return for each of the relevant financial years. (4) The value of shares still held by the taxpayer decreases as a result of market conditions and the taxpayer has an unrealised loss in respect of those shares. (5) The taxpayer may receive advice from a tax professional or financial advisor regarding the deductibility of losses incurred on the sale of shares for the current income year, including the benefits of being regarded as holding shares as a share trader when making such a loss. (6) Without changing the economic substance of their shareholdings, the taxpayer decides to arbitrarily re-characterise their shareholding in order to claim the net loss from their sale as a revenue deduction pursuant to s 8-1 of the ITAA97, on the basis that the taxpayer is now carrying on a business of share trading (as opposed to carrying forward capital losses indefinitely to be offset against any future capital gains, as would be the case for an investor). (7) To support a contention that the taxpayer is carrying on a business of share trading, the taxpayer may artificially adopt specific practices to present a pretence of being a share trader, but with no objective, material change in either the nature of investments held (or sold) or their holding activities. Some of these practices (which in the relevant circumstances a reasonable person would regard as artificial and contrived) may include: • purchasing or selling shares on a more regular basis (often with small net volumes), ie “window dressing” • creating a trading plan for their share transaction activities with a newly stated goal of maximising profit — even though the shares sold will generate a loss rather than a profit • increasing recording of time spent per week on the investment process (without any significant change in the total value of transactions), and • maintaining additional records to evidence share transactions including additional reliance on guidance from others (without any significant change in the total value of transactions). (8) The taxpayer subsequently decides to dispose of the shares to realise the net loss. (9) The change in approach is applied on a prospective basis only, such that only future transactions are affected, even though there has been no substantive change in objective facts between the current year and previous years.

Example The following is an example of a taxpayer’s arrangement in a particular case: • January 2009 — taxpayer purchased 100,000 listed shares in an entity. • May to December 2010 — taxpayer disposed of 50,000 shares and was assessed on the capital gain/loss. With a capital gain, the taxpayer claimed the 50% CGT discount (¶2-215). Any net capital loss incurred was offset against current or future capital gains in accordance with ITAA97 Div 102 (¶2-210). • October 2011 — the stock market crashed. • November 2011 — taxpayer disposed of remaining 50,000 shares at a net loss and claims an immediate deduction against other incomes, rather than carrying forward the loss as a capital loss.

Artificially creating capital losses through default beneficiary arrangement Taxpayer Alert TA 2009/14 warns about arrangements where a taxpayer with a current or future capital gain attempts to artificially create an offsetting capital loss by becoming a default beneficiary for a discretionary trust (for no consideration) and then transferring their interest in that trust (for no consideration). These arrangements have the following features: (1) A trust is established for the benefit of discretionary objects. (2) The deed for that trust confers discretionary powers of appointment of income and capital on the trustee or a third party appointor. (3) The trust has a named default beneficiary who on the termination date will take any trust capital that has not been appointed. (4) The default beneficiary may also be one of the discretionary objects. (5) The default beneficiary does not give any money or property to acquire the interest in the trust capital. (6) The default beneficiary assigns all their interests (default and discretionary interests) in the trust to a third party (for example, a spouse). (7) The assignment of rights to trust capital is said to produce entitlement to a capital loss for the default beneficiary (under CGT event E8). Trusts avoiding CGT by exploiting restructure rollover Taxpayer Alert TA 2009/2 warns about arrangements that purportedly allow a unit trust to effectively dispose of a CGT asset to an arm's length purchaser with no CGT consequences. The arrangements seek to exploit the CGT rollover for trust restructures provided by Subdiv 126-G (¶2-410). Under these arrangements, a trustee of a unit trust (Transferring Trust) sells a CGT asset (Relevant Asset) with a large unrealised capital gain to an arm's length purchaser (Purchaser) for an agreed purchase price (Purchase Price) by way of: • transferring the Relevant Asset to a trustee of a new unit trust (Receiving Trust) for the Purchase Price which gives rise to a debt owing to the Transferring Trust • choosing rollover under Subdiv 126-G for the transfer • the Purchaser subscribing for new units in the Receiving Trust equal in value to the Purchase Price, and • the Receiving Trust repaying the debt to the Transferring Trust with the funds received from the issue of the new units. By entering into these arrangements rather than selling the Relevant Asset directly to the Purchaser, the

Transferring Trust is able to transfer the underlying ownership of the Relevant Asset to the Purchaser but purportedly avoids tax on the large capital gain that would otherwise have been made with an asset sale. ATO advice under development For tax and financial planning purposes, readers should also have regard to the following CGT issues that the ATO is currently reviewing (ATO references are in square brackets): • [3802] Trust capital gains • [3803] Capital gain from a non-resident beneficiary of a non-fixed trust • [3953] Back-to-back CGT roll-overs • [3964] Appointment of capital – CGT event E5 or E7 • [3965] Australian currency denominated asset – CGT events E5 to E7 • [3966] Unit trust – CGT events E5 to E8 • [3968] Small business concessions – active asset test • [3973] The first element of cost base and other deductible expenditure (www.ato.gov.au/General/ATO-advice-and-guidance/Advice-under-development-program/Adviceunder-development---capital-gains-tax-issues/).

¶2-700 CGT topical checklist The checklist below is adapted from the CGT checklist published by the ATO. It sets out the relevant questions to ask in respect of the more common CGT assets or circumstances and serves as an alert to the possibility of a capital gain or loss arising in the current year or in future, and the need to keep appropriate records. This checklist is not exhaustive and may be used in conjunction with the planning checklist at ¶2-600. Real estate — current year CGT impacts ☐ Have you sold or given away real estate in the past financial year (including your main residence)? ☐ Has there been a change to the title of real estate that you owned (or partially owned) at the start of the year? ☐ Have you granted an option, conservation covenant or other right (eg an easement over real estate) in the year? ☐ Have you granted, changed or varied a lease over your real estate in the past year? ☐ Has any building or capital improvement on your land been destroyed in the past year? ☐ Did you receive compensation in the past year in respect of real estate you own? ☐ In the past year, have you sold any rights you held in real estate (eg contractual rights relating to an off-the-plan purchase)? Real estate — future year CGT impacts ☐ Do you own real estate (including an inheritance) that is not your main residence (eg land, investment property or holiday house)? ☐ Do you own real estate that is your main residence and it is: – used as a place of business or to derive rent or has not been your main residence the whole time you owned it

– situated on more than two hectares of land, or – a different home from your spouse or dependent child (under 18 years old)? ☐ Have you made any capital improvements to any real estate that you own? ☐ Have you subdivided or amalgamated any real estate that you own? Shares and investment units ☐ Do you own any shares, units in a unit trust or other investments (eg convertible notes)? ☐ Did your interests change during the year (ie they were sold, transferred, cancelled or ended)? ☐ Did your interests in an employee share scheme change? ☐ Did you receive compensation in the past year in respect of any investments you own? ☐ Did you receive a non-assessable payment from a company or trust in which you have an investment? ☐ Did you receive a distribution from a trust that includes a capital gain? ☐ Has the trustee provided you with a statement indicating how they calculated the trust’s capital gain? ☐ Has the entity in which you own an investment been involved in a takeover, demerger, demutualisation or merger, or gone into liquidation, or conducted a share buyback? ☐ Did you acquire any of your shares or units: – under a dividend or distribution reinvestment plan – under a bonus issue, or – as the result of the exercise of a right or option to acquire additional shares/units? Trust distributions ☐ Are you a beneficiary of a trust (ie other than one in which you hold units as an investment)? ☐ Have you received a distribution from a trust that includes a capital gain? ☐ Has the trustee of a trust provided you with a statement indicating how it has calculated the trust’s capital gain in respect of a distribution to you? ☐ Have you received a distribution from a trust that includes a non-assessable payment, and has the trustee provided you with a statement indicating the nature of the distribution (eg tax-free amount, CGT concession amount, tax-exempted amount, tax-deferred amount)? Business ☐ Do you own a small business or have an interest in one? ☐ Did you dispose of all or some of the assets of a business during the year? ☐ If you did dispose of any business assets, did you account for GST on those assets? ☐ Did you acquire a business or business assets during the year? Marriage/relationship breakdown ☐ Have you acquired an asset, or an interest in one, from your former spouse/partner after a

marriage/relationship breakdown? ☐ Did you acquire the asset as the result of a court order, consent order, an arbitral award, or a binding financial agreement or similar agreement under a state law? Deceased estates ☐ Are you the legal personal representative (LPR) or beneficiary of a deceased person’s estate? ☐ Have you (as the LPR) distributed, or have you (as a beneficiary) received a distribution of, an asset from the deceased estate? Other CGT events, assets or capital proceeds ☐ Has your interest in a collectable acquired for more than $500 changed (including items such as art, antiques, valuable metals, jewellery, coins or medallions, rare books and manuscripts, and postage stamps)? ☐ Has your interest in a personal use asset acquired for more than $10,000 changed (including items such as boats, furniture, electrical goods and household items)? ☐ Have you received or become entitled to a capital payment (including compensation, restrictive covenants, contingent payments, or other consideration for an act, transaction or event)? Record keeping ☐ Have you kept appropriate records of your CGT assets to enable you to calculate the correct amount of a capital gain or loss made when a CGT event happens? ☐ Are you aware of the need to keep these records for five years after the last relevant CGT event? ☐ Are you aware that an asset register may enable you to discard records that would otherwise need to be kept? ☐ Do you have a prior year capital loss that has been carried forward? ☐ Have you considered the GST implications in relation to your CGT events?

FRINGE BENEFITS TAX The big picture

¶3-000

What is FBT?

¶3-050

The FBT basics

¶3-100

Who pays FBT?

¶3-150

Reportable fringe benefits

¶3-155

What is a fringe benefit?

¶3-200

Calculating FBT How is the amount of FBT calculated?

¶3-300

Calculating taxable values

¶3-400

Car benefits

¶3-410

Car parking fringe benefits

¶3-420

Expense payment benefits

¶3-430

Loan fringe benefits

¶3-440

In-house benefits

¶3-445

Living-away-from-home allowance fringe benefit

¶3-450

The “otherwise deductible” rule

¶3-500

Employee contribution towards a benefit

¶3-550

FBT exemptions and concessions Exemptions from FBT

¶3-600

Exempt employers and rebatable employers

¶3-650

Other FBT concessions and caps

¶3-700

FBT planning Reducing your FBT liability

¶3-800

Salary packaging or sacrifice

¶3-850

Impact on employees of reportable fringe benefits ¶3-900 Fringe benefits — interaction with other taxes

¶3-950

¶3-000 Fringe benefits tax and financial planning

The big picture What is fringe benefits tax?: Fringe benefits tax (FBT) is a tax on employers which is levied on the value of fringe benefits provided to employees in respect of their employment in an FBT year. The effect of FBT is to impose tax on employee remuneration, regardless of whether it is in the form of cash salary or fringe benefits. An FBT year runs from 1 April to the following 31 March. The principal legislation dealing with FBT is the Fringe Benefits Tax Assessment Act 1986 (FBTAA) and Fringe

Benefits Tax Assessment Regulations 2018. FBT is imposed by the Fringe Benefits Tax Act 1986. ¶3-050 When does FBT apply?: For FBT to apply: • there must be an employer–employee relationship ¶3-100 • a benefit must be provided in respect of the employment relationship ¶3-100. Who pays FBT?: FBT is payable by the employer. ¶3-150 Reportable fringe benefits: An employer is required to report the grossed-up taxable value of fringe benefits (except excluded benefits) where the value of the benefits exceeds $2,000. ¶3-155 Benefits — valuation and exemption: Benefits are divided into categories for valuation and exemption purposes. Any fringe benefit which is not exempt and does not fall into a specific fringe benefit category is valued as a residual fringe benefit. ¶3-200 How is FBT calculated?: FBT is levied on the “fringe benefits taxable amount”, ie the taxable value grossed-up by the relevant factor. ¶3-300 Calculating taxable values: Each benefit category has specific rules for calculating the fringe benefits taxable value: • car parking ¶3-410 • car parking benefits ¶3-420 • expense payment benefits ¶3-430 • loan benefits ¶3-440 • in-house benefits ¶3-445 • living-away-from-home allowance benefits ¶3-450. The “otherwise deductible rule”: The taxable value of a fringe benefit provided to an employee can be reduced under the “otherwise deductible rule”. ¶3-500 Employee contribution: If an employee makes a contribution towards the provision of a benefit, the taxable value of the benefit is reduced by the amount of the contribution. ¶3-550 Exemptions and concessions: There are several reasons why a benefit provided to an employee may not attract FBT. They may be exempt benefits (¶3-600) or the employer may be classed as an exempt or rebatable employer. ¶3-650 Reducing an FBT liability: An employer may negotiate strategies to reduce or eliminate its FBT liability. Strategies have to be looked at in al total remuneration context (ie total employment cost) for each employee as they may have tax consequences depending on the employee’s particular circumstances. ¶3-800 Reducing the impact of reportable fringe benefits on employees: There are some considerations an employee may take to reduce the impact of reportable fringe benefits. ¶3-900

¶3-050 What is FBT? An FBT year begins on 1 April and ends on 31 March. Fringe benefits tax (FBT) applies to the value of benefits provided by an employer or associates of the employer to a past, present or future employee in respect of the employee’s employment (fringe benefits).

It also applies to benefits provided to an associate of the employee (eg a spouse or partner, including a same-sex partner). FBT is payable at the FBT rate (see below) on benefits provided to resident employees except where the employee’s salary or wages is exempt from income tax, and to non-resident employees with Australiansourced salary or wages income. FBT is based on self-assessment by an employer, and any FBT amount payable is paid by the employer, generally in four instalments. The FBT regime taxes the benefits provided to employees so that, unless the fringe benefits are concessionally taxed, it makes little difference whether the benefits are provided to the employees directly or by additional cash salary. Whether an employee is remunerated on a salaryonly basis or with a combination of benefits, the amount of tax payable should be the same. FBT is applicable regardless of whether the employer is exempt from income tax or other taxes. Public benevolent institutions, public and not-for-profit hospitals, public ambulance services and certain other tax-exempt entities such as charitable institutions are exempt from FBT or are entitled to a tax rebate for FBT up to an annual cap per employee (see ¶3-650). Generally, the employer can claim a tax deduction for the cost of providing fringe benefits and the FBT paid (¶3-950). For the interaction of FBT and goods and services tax (GST), see ¶3-950. FBT rate The FBT rate is 47% for the FBT year ending 31 March 2020 (the same as the previous year).

¶3-100 The FBT basics A fringe benefit is a benefit provided in respect of employment. Therefore, for an FBT liability to arise, the following must be present: • an employer–employee relationship • a benefit provided to the employee (or employee’s associate) in respect of the employee’s employment. Providing benefit in lieu of cash remuneration to employee A person is an employee if cash remuneration paid to the person in the same context as that in which the benefit was provided would be treated as salary or wages for Pay As You Go (PAYG) purposes. The employer is liable for FBT regardless of whether it is a sole trader, partnership, trustee, corporation, unincorporated association, government department or authority (¶3-150). Benefit provided in respect of employment relationship A benefit must be provided by an employer or associate of the employer to the employee or the employee’s associate (see below) in respect of the employment of the employee. The term “benefit” is defined widely and will catch virtually most benefits provided to an employee in respect of employment (¶3-200). However, there are some exceptions or exemptions (see “Some benefits are not fringe benefits” below). A key test is that the benefit is provided in respect of the employee’s employment. For example, a benefit provided to a person as a shareholder or as a gift is not a fringe benefit. A mere causal link with employment of the employee is not sufficient. The courts have considered the expression “in respect of” in various statutory contexts. In the FBT context, the Full Federal Court noted that: “what must be established is whether there is a sufficient or material, rather than a causal connection or relationship between the benefit and the employment”. The court also suggested that it would be useful to ask “whether the benefit is a product or incident of the employment” (J & G Knowles & Associates Pty Ltd v FC of T 2000 ATC 4151).

Example An industrial award requires an employer to reimburse an employee for the employee’s home telephone rental cost. The reimbursement is a fringe benefit (ie a benefit provided in respect of employment) if the reimbursement was made only because of the award provisions and would not have been made for a non-employee.

A particular employee (rather than a group of employees) must be identified with a fringe benefit provided by an employer. When determining whether there is a “fringe benefit”, it is necessary to identify, at the time a benefit is provided, a particular employee in respect of whose employment the benefit is provided. Whether a particular employee can be so identified and whether that gives rise to a fringe benefit are questions of fact to be determined on a case-by-case basis (FC of T v Indooroopilly Children Services (Qld) Pty Ltd 2007 ATC 4236; ID 2007/194: discretionary trust for employees; employee remuneration trust: ¶3-430). In Indooroopilly, the shares provided to the trustee (which constituted the contribution to the employee remuneration trust) were not provided in respect of the employment of any particular employee; also, not all of the employees capable of benefiting would in fact receive a benefit. That is, only some employees may subsequently benefit and their identity was not known. For a case where a fringe benefit was held to be provided in respect of a particular employee based on the particular facts of the case, see Caelli Constructions (Vic) Pty Ltd v FC of T 2005 ATC 4938 (¶3-200). Associates, relatives, friends and arrangements The term “associate” is defined by reference to its meaning in the income tax Acts. An “associate” of a person includes relatives, partners, trustees and beneficiaries, and related companies (FBTAA s 136(1), 159). A friend of an employee is generally not an “associate” under the tax law. However, a third party can be deemed to be an employee’s associate if the third party receives a benefit provided under an “arrangement” between the employer and employee (FBTAA s 148(2)). An “arrangement” is defined widely in s 136(1). It means: • any agreement, arrangement, understanding, promise or undertaking (express or implied), and whether or not enforceable, or intended to be enforceable, by legal proceedings, and • any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. Accordingly, if a benefit is provided to a friend of an employee under an “arrangement” between the relevant parties, the friend (as the recipient of the benefit) qualifies as an associate and the benefit provided can be a fringe benefit (ID 2010/97). Example By reason of an employment relationship, an agreement is entered into whereby the employer provides the employee’s friend (who is not an employee or associate) with the ongoing use of a car. The car is owned and maintained by the employer. Each use of the car by the employee’s friend is the provision of a “benefit” (¶3-200) and may be a fringe benefit.

Key question — whether a benefit is provided in respect of employment is a fringe benefit The key question for an employer to ask is: “Would the benefit have been provided if the recipient had not been an employee?” Some benefits are not fringe benefits The more common forms of fringe benefits are discussed at ¶3-200. Not all benefits provided in respect of employment are fringe benefits. The main benefits expressly excluded as fringe benefits by the FBTAA definition of “fringe benefit” include: • salary or wages

• a benefit that is an exempt benefit • employee share acquisition scheme benefits — benefits to employees from the acquisition of shares, or rights to acquire shares, are not fringe benefits if the schemes comply with the income tax law (¶3600) • superannuation contributions (in cash or in specie) — but not contributions provided for an associate of an employee • a superannuation benefit (within the meaning of the Income Tax Assessment Act 1997 (ITAA97)) • employment termination payments (including early retirement scheme or genuine redundancy payments, certain unused leave payments) — lump sums (or property) given to an employee in consequence of the termination of employment • payments of a capital nature • dividends, and • certain payments made by partnerships and sole traders to relatives or associates that are deemed not to be assessable income (see “Certain payments or benefits are not fringe benefits” at ¶3-600). Benefits which are stated not to be “fringe benefits” under the FBTAA are not the same as “exempt benefits”, which are fringe benefits but are expressly not subject to FBT — see “Exempt employers” (3650) and “Exempt benefits” (¶3-600). Reimbursing volunteer workers for out-of-pocket expenses does not make them employees. In most cases, benefits provided to genuine volunteer workers (eg accommodation and basic meals) do not give rise to a fringe benefit (ATO factsheet “Volunteers and FBT”, www.ato.gov.au/non-profit/yourworkers/your-volunteers/volunteers-and-fbt/). Other examples of benefits that are not fringe benefits include: (a) accommodation and meals provided in the family home to children of a primary producer who works on the family farm (b) board provided in the family home to a son who is apprenticed to his father as a motor mechanic (c) birthday presents given by parents to their children who work in a family small business (d) wedding gifts given to a child by the parents where the child has worked in the family business, and (e) an interest-free or low-interest loan given by parents to a child to purchase a matrimonial home. In the cases above, the benefits and gifts have been given in an ordinary family setting as a normal incidence of family relationships, rather than being provided in respect of either past or current employment of the recipients (MT 2016). What to do if you provide fringe benefits? The following is a summary of the things that an employer needs to do if it provides fringe benefits: • identify the employee receiving the benefit • calculate how much FBT is payable • keep the necessary FBT records • register with the Australian Taxation Office (ATO) for FBT purposes • report the fringe benefits on the employee’s payment summary

• report the fringe benefits on the ATO form and pay FBT to the ATO. Scope of this chapter and additional guidelines The FBT regime is wide-ranging and a comprehensive coverage of the FBT rules is beyond the scope of this Guide. This chapter covers the features of the main fringe benefits and operation of the key FBT rules, with particular focus on the more common benefits and aspects which may impact on financial planning. Case studies on salary packaging are covered in Chapter 10 of this Guide. Comprehensive FBT commentary may be found in other Wolters Kluwer tax services, such as the Australian FBT commentary service and Australian Master Tax Guide. The ATO provides detailed information on the operation of the FBT regime in: • “Fringe benefits tax — a guide for employers” (www.ato.gov.au/general/fringe-benefits-tax-(fbt)/indetail/fbt---a-guide-for-employers/) and “Fringe benefits tax for small business” (www.ato.gov.au/General/Fringe-benefits-tax-(FBT)/In-detail/Getting-started/FBT-for-small-business), and • Advice under development — FBT issues www.ato.gov.au/General/ATO-advice-and-guidance/Adviceunder-development-program/Advice-under-development---FBT-issues/.

¶3-150 Who pays FBT? FBT is payable by the employer, regardless of whether the employer is a sole trader, partnership, trustee, corporation, unincorporated association, government department or authority. The tax is payable whether or not the employer is liable to pay other taxes such as income tax. FBT is paid by the employer even where the fringe benefits are provided by an associate of the employer (eg a related company, relatives or partners), or by a third party under an arrangement with the employer or associate. The term “arrangement” is defined widely in the FBTAA. It can include an understanding between two or more persons and need not necessarily be evidenced in writing or by a verbal agreement. It can cover any scheme, plan, proposal, action, course of action or conduct, including an action taken by one person without the knowledge of the other party (see “Associates, relatives, friends and arrangements” in ¶3100). Generally, employers may claim the cost of providing fringe benefits and the amount of FBT paid as income tax deductions. A benefit is subject to FBT in an FBT year FBT is imposed on the employer in the FBT year in which the benefit is actually provided to the employee or employee’s associate. The FBT year runs from 1 April to 31 March. When is FBT incurred by an employer? An FBT liability imposed under s 5 of the Fringe Benefits Tax Act 1986 on an employer’s FBT taxable amount in a year of tax arises at the end of that year of tax, and the employer has a presently existing liability at that time for the amount of the FBT payable. That is, an FBT liability for an FBT year, assessed under an assessment made by the Commissioner, is incurred for the purposes of s 8-1 of the ITAA97 (the general deduction for tax purposes), regardless of how FBT is assessed (Taxation Ruling TR 95/24). Therefore, if an FBT assessment is issued for an earlier year, the FBT is incurred in that earlier year rather than in the year in which the assessment is issued (Taxation Determination TD 2004/20). A later refund or reduction of the FBT liability as a consequence of an amended assessment is an assessable recoupment (Taxation Determination TD 2004/21) (see also ¶3-800). Non-resident employers Subject to certain exceptions, a non-resident employer who pays an Australian resident for work performed overseas is subject to withholding obligations in accordance with s 12-35 of Sch 1 to the Taxation Administration Act 1953 (TAA) if the employer has a “sufficient connection with Australia” (this is

a matter of statutory interpretation having regard to the PAYG withholding provisions in the TAA). A nonresident employer will have a sufficient connection to Australia if it has a physical business presence in Australia, eg the employer carries on an enterprise or income-producing activities in Australia and has a physical presence in Australia. These circumstances are most likely to arise in the case of a multinational business which carries on business in Australia. If a withholding obligation applies, the employer will also have FBT obligations for any benefit provided in respect of the employment of that person (Taxation Determination TD 2011/1). Example Molly (an Australian resident for tax purposes) is employed as a project manager working in the Australian operations of a nonresident company. The company transfers Molly overseas for five months to work on a new project. The company continues to carry on business and maintains a physical presence in Australia. Molly’s wages are assessable income in Australia, and the company has an obligation to withhold tax from the salary paid to her. Molly is provided with a car while overseas, and is reimbursed for some additional living expenses. As amounts must be withheld from her salary, the employer would have FBT obligations in respect of the benefits provided to her.

Example Lauren (an Australian resident for tax purposes) works for an Australian subsidiary of an international hotel chain as an events manager. She was offered a six-month overseas secondment with the group’s global parent company, which is a non-resident for tax purposes and does not carry on business in Australia. While on secondment, she will be employed and paid by the parent company. Her employer, being the non-resident parent company not carrying on business in Australia and with no physical presence in Australia, has no obligation to withhold Australian tax from the salary paid to her. As there is no obligation to withhold, no obligations under the FBTAA can arise to her non-resident employer in respect of any benefits provided to her. Lauren will be required to include this employment income and the value of any benefits received from the non-resident employer in her Australian assessable income.

¶3-155 Reportable fringe benefits An employer is required to report to the ATO the grossed-up taxable value of fringe benefits (except excluded benefits) provided to an employee on the payment summary given to the employee where the value of the benefits exceeds $2,000 in the FBT year. The value of the “reportable fringe benefits amount” (RFBA) is not included in the employee’s assessable income, but is used to determine the employee’s entitlement to certain income-tested tax concessions and liability to income-tested surcharges (¶3-900). The RFBA is based on the fringe benefits provided for the FBT year (1 April to 31 March) for the corresponding income year (1 July to 30 June). From 1 July 2018, an employer may choose to report an employee’s RFBA (or reportable employer superannuation contributions: see below) under the single touch payroll (STP) reporting rules in the TAA. Gross-up FBT rate for reporting on payment summary When determining the amount of reportable fringe benefits to be shown on an employee’s payment summary for the 2020/21 FBT year, the employee’s individual fringe benefits amount is grossed-up using the rate of 1.8868 (the Type 2 gross-up rate). The FBT gross-up rate of 2.0802 (the Type 1 gross-up rate which is used when the employer is able to claim GST credits for benefits provided to the employee) is not used to calculate the employee’s reportable fringe benefits amount as that rate only applies to the calculation of an employer’s FBT liability (¶3-300). Allocating fringe benefits between employees The requirement to report fringe benefits on payment summaries means that employers have to allocate the value of fringe benefits to individual employees. Where a benefit is provided to two or more employees, the amount reported is the share that reasonably reflects the benefit received by each employee. An agreement between the employee and employer relating to a reasonable method of apportionment may be used to allocate the taxable value of a benefit for employees.

The value of all fringe benefits, other than excluded fringe benefits, must be allocated to the relevant employees. Some exempt benefits need to be reported Some benefits which are exempt from FBT may still need to be reported on the employee’s payment summary. These are benefits that are exempt only because they are provided to: • certain live-in residential care workers where the employer is a government body, religious institution or a non-profit company, or • employees of public benevolent institutions, including employees who work in public hospitals. The FBT exemptions for these benefits continue to apply, but for reportable fringe benefits purposes, the notional taxable value of these benefits (called “quasi fringe benefits”) has to be allocated to the employee. Excluded benefits are not reportable “Excluded fringe benefits” do not have to be reported for reportable fringe benefits purposes, but may still be subject to FBT. Excluded fringe benefits include the following: • entertainment by way of food and drink, and associated benefits such as travel and accommodation • pooled or shared private use of the employer’s car by employees, ie a vehicle provided for the private use of two or more employees resulting in a car fringe benefit for more than one employee (ID 2008/21) • car parking fringe benefits (other than eligible car parking expense payments) • hiring or leasing entertainment facilities (eg corporate boxes) • remote area residential fuel, housing assistance, or home ownership or repurchase schemes, where the value of the benefit is reduced • freight costs for food provided to, and costs of occasional travel to a city by, employees and their families living in a remote area (ID 2009/24: occasional travel) • emergency or essential health care provided to an employee or associate who is an Australian citizen or permanent resident, while working outside Australia, where no Medicare benefit is payable • benefits provided to address security concerns relating to an employee’s or associate’s personal safety arising from employment • certain overseas living allowance payments by the Commonwealth • certain benefits provided to Defence Force members • certain living-away-from-home allowances, expense payment benefits and residual benefits provided to Commonwealth employees (FBTAA s 5E(3); Fringe Benefits Tax Assessment Regulations 2018 s 5–12). Reportable employer superannuation contributions Reportable employer superannuation contributions (RESC) are contributions made by an employer which are additional to their mandatory superannuation guarantee contributions (9.5% in 2020/21 and 2019/20) and are made for an individual’s benefit where the individual has, or might reasonably be expected to have, some capacity to influence the size of the contribution or the way in which the contribution was made so that the individual’s assessable income is reduced (¶4-215). Employer superannuation contributions for employees are not fringe benefits under the FBTAA (¶3-600). They also do not come within the reportable fringe benefits reporting regime, but employers must report RESC amounts to the ATO under the TAA as these amounts are included in the income tests to determine access to various tax

concessions and government benefits (¶3-900).

¶3-200 What is a fringe benefit? A fringe benefit is a benefit provided by employers to employees in respect of their employment. A “benefit” includes any right (including a right or interest in real or personal property), privilege, service or facility. The term is broadly defined so that it captures most forms of benefits provided to an employee. For example, providing a car for an employee’s use or reimbursing an employee’s private expenses will fall within the definition of “benefit”. Some forms of benefits are expressly excluded as “fringe benefits” and do not give rise to any FBT liability (¶3-600). Benefits — valuation and exemption Benefits are divided into categories for valuation and exemption purposes. Any fringe benefit which is not exempt and does not fall into a specific fringe benefit category is valued as a residual fringe benefit. Categories of benefits with specific valuation and exemption rules include: • car benefits • car parking benefits • loan benefits • debt waiver benefits • expense payment benefits • housing benefits • living-away-from-home allowance benefits • property benefits • entertainment benefits • airline transport benefits • board benefits • residual benefits. Car benefits A car fringe benefit generally arises when a car which is owned or leased by an employer is either used privately by, or made available for the private use of, an employee (FBTAA s 7(1)). A car is treated as being made available for private use by an employee on any day that: • the car is not at the employer’s premises, and the employee is allowed to use it for private purposes, or • the car is garaged at the employee’s home (regardless of whether they have permission to use it for private purposes). Generally, travel to and from work is private use of a vehicle. Where the place of employment and residence are the same, the car is taken to be available for the private use of the employee. A car (which does not include a motorcycle) includes: • a sedan, four-wheel drive, station wagon, panel van or utility designed to carry a load of less than one tonne

• any other road vehicle designed to carry a load of less than one tonne or fewer than nine passengers. Private use of a motor vehicle that is not a car may be a residual fringe benefit (see below). The two methods of valuing a car fringe benefit are the statutory formula method and the operating cost method (¶3-410). Exempt car benefits An employee’s private use of a car used for taxi travel (other than a limousine), or a panel van, utility or other road vehicle (ie one not designed principally to carry passengers) is exempt from FBT if there was no private use of such a vehicle other than: • work-related travel (ie travel between home and work or incidental private travel in the course of performing employment-related duties), and • other private use that is minor, infrequent and irregular (eg occasional use of the car to remove domestic rubbish) (FBTAA s 8(2)). Where an employee’s duties of employment are inherently itinerant in nature, the transporting of the employee’s family member by the employee on their journey from home to a particular work location is not a business journey, but a private use of the car (ID 2012/96; ID 2012/97). However, it is an excepted private use under s 8(2)(b) if the use of the car for this purpose is minor, infrequent and irregular (ID 2012/98). Travel by an employee in their employer’s car between their place of residence and the employee’s place of employment in relation to a second employer is not “work-related travel” within the meaning in FBTAA s 136(1). An employee’s place of employment for this purpose relates only to the employment relationship under which the car benefit is provided (ID 2013/34). A car benefit is an exempt benefit in relation to an FBT year if the person providing the benefit cannot deduct an amount under the ITAA97 for providing the benefit because of s 86-60 (ie the “personal services income” rules). That section limits the extent to which a personal services entity can deduct car expenses (eg a deduction will not be allowed for more than one car for private use). The use of these cars is an exempt benefit because the entity is not entitled to claim an income tax deduction for these cars. Where a car is destroyed in a natural disaster, is it not considered to be a car that is held by the employer from the date it was destroyed? That is, the calculation of the taxable value of the car fringe benefit provided will only take into account the period up to the date of the natural disaster (ID 2011/28). ATO compliance approach to determine limited private use of vehicles As noted above, a fringe benefit is an exempt benefit where the private use of eligible vehicles by current employees during an FBT year is limited to work-related travel, and other private use that is “minor, infrequent and irregular” (FBTAA s 8(2) and 47(6): car-related exemptions). Practical Compliance Guideline PCG 2018/3 sets out the ATO’s compliance approach to determining the private use of vehicles with respect to exempt car benefits and exempt residual benefits where the conditions specified in the Guideline are met (eg private travel is within specified distances). Employers do not need to rely on the Guideline, but where they do: • they do not need to keep records about an employee’s use of the vehicle to demonstrate that the private use is “minor, infrequent and irregular”, and • the Commissioner will not devote compliance resources to review that the employer can access the car-related exemptions for that employee (PCG 2018/3, para 6 and 7). Car parking benefits A car parking fringe benefit arises where an employer provides an employee with a car parking facility in certain specified circumstances (¶3-420). By contrast, a car parking expense payment benefit may arise if an employee incurs expenditure on car parking and:

• the employer reimburses the employee or pay for the car parking expenses on behalf of the employee • the car is parked at or near the employee’s primary place of employment for more than four hours between 7 am and 7 pm on the day the expenses are incurred, and • the car is used by the employee to travel between home and work on that day. In the case of car parking expense payment benefit, the proximity to a commercial parking station and the daily fee charged by it are not relevant. To calculate the taxable value of a car parking benefit, the employer has to determine the taxable value of a single car parking fringe benefit and the total number of car parking fringe benefits provided to employees using the prescribed methods discussed at ¶3-420. Exempt car parking benefits The following car parking benefits provided to employees are exempt from FBT: • residual benefit — parking provided that does not satisfy all the car parking fringe benefits conditions (¶3-420). The benefit in this case is a residual benefit that is exempt from FBT • expense payment benefit — if the employer pays or reimburses a car parking expense incurred by an employee and the expense is not a car parking expense payment fringe benefit (see above) • car parking for the disabled — car parking provided for a car used by a disabled employee. Small business employer exemption A small business employer is exempt from FBT for car parking benefits provided: • the parking is not provided in a commercial car park • the employer is not a government body, a listed public company or a subsidiary of a listed public company, and • the employer’s total income (total gross income before any deductions) for the last income year before the relevant FBT year was less than $10m. Loan benefits A loan fringe benefit arises where an employer makes a loan to an employee and there is an obligation for the recipient to repay the loan (eg an interest-free or low-interest loan). A loan fringe benefit also arises where an employer allows a debt owed by an employee to run past the due date for payment. The benefit exists for as long as the debt remains unpaid. The taxable value of a loan fringe benefit is the difference between a statutory benchmark rate of interest and any interest actually accruing on the loan (¶3-440). Exempt loans A loan benefit may be exempt from FBT if: • the employer is engaged in the business of money lending and the loan interest rate to the employee is fixed at a rate at least equal to the rate applicable under a comparable loan made to the public in the ordinary course of business at about the time of the loan • the employer is engaged in a business of money lending and, for each income year over which the loan extends, the interest rate is variable, but never less than the arm’s length rate charged on loans made about the time the loan was made to the employee • the employer advances money to the employee solely to meet expenses to be incurred within a sixmonth period of the advance being made and the expense is incurred in carrying out employmentrelated duties. The expenses must be accounted for by the employee and any excess advance refunded or otherwise offset

• the employer makes an advance, repayable within 12 months, to an employee solely to pay a security deposit (eg a rental bond or service connection deposit) in respect of accommodation where the accommodation gives rise to an exempt benefit (as a relocation “living away from home accommodation”) or the accommodation is temporary accommodation eligible for a reduced taxable value in accordance with the relocation concessions. FBT does not apply to a loan in relation to a shareholder (or an associate of the shareholder) in a private company that causes the private company to be taken to have made a deemed dividend payment to the shareholder or associate under Div 7A of the Income Tax Assessment Act 1936 (ITAA36) (¶1-400). Debt waiver benefits If an employer releases an employee from a debt, a debt waiver benefit will arise if the waiver is connected with the employee’s employment. A debt which is not waived but remains unpaid gives rise to a loan benefit. The loan benefit will remain until the loan is repaid or repayment is waived. The taxable value of the debt waiver benefit is the amount of the debt waived. Division 7A deemed dividends Where a loan benefit or a debt waiver benefit is provided by a private company to an employee (or associate) who is also a shareholder (or associate), a fringe benefit does not arise if the loan or debt waiver results in the company being taken to have paid a dividend under Div 7A of the ITAA36 to the shareholder (or associate). Expense payment benefits An expense payment benefit arises where an employer: • pays for or reimburses expenses incurred by an employee, or • pays a third party in satisfaction of expenses incurred by an employee (FBTAA s 20). A reimbursement requires the employee to be compensated exactly for an expense already incurred in contrast to an allowance paid to an employee by an employer. A payment for or reimbursement of a training course or activity for an employee who has been made redundant is an expense payment benefit (ATO ID 2015/1). It is not exempt because it is not “work-related counselling” (as defined in FBTAA s 136(1)). External expense payment fringe benefit If an employer pays an employee’s salary sacrificed amount to the trustee of a trust as repayments of principal on an interest-free loan from the trust, the employer has provided an external expense payment fringe benefit to the employee. The taxable value of the external expense payment fringe benefit is equal to the amount of the loan repayment (FBTAA s 23). This is because each repayment on the loan is a repayment of principal on an interest-free loan and the employee would not have been entitled to an income tax deduction had the employee incurred and paid these amounts. In-house exempt payment fringe benefit An in-house expense payment fringe benefit arises where the expenditure reimbursed or paid for was incurred by the employee (or family member) in purchasing goods or services that the employer (or an associate) sells to customers in the ordinary course of your business. The benefits are two types — an inhouse property expense payment fringe benefit and an in-house residual expense payment fringe benefit. Example Employer ABC is a manufacturer which markets its products through independent retailers. The employees of ABC purchase those products from the retailers at full retail price, but subsequently receive a reimbursement from ABC for part of the purchase price. The reimbursement is an in-house property expense payment fringe benefit.

The taxable value of an expense payment benefit is the amount of the expenditure incurred by the

employee which is paid or reimbursed by the employer (¶3-430). Exempt expense payment benefits The provision of an expense payment benefit (or a property benefit or residual benefit) in respect of an “eligible work-related item” will be an exempt expense payment benefit where it is provided in relation to an “exempt benefit” (¶3-600). Housing benefits A housing benefit will arise where an employer provides accommodation to or gives an employee a right to occupy a unit of accommodation as a usual place of residence for more than one day. The right to occupy may be under a lease or licence and may cover any type of accommodation, provided it is the employee’s usual place of residence. The taxable value of the housing benefit will generally be the market value of that right reduced by any contribution made by the employee. A remote area housing benefit (eg accommodation provided to employees in remote areas) is FBT-exempt (see “Remote area concessions”: ¶3-700). Living-away-from-home allowance (LAFHA) benefit A LAFHA benefit arises if an employer pays an employee an allowance to cover additional expenses incurred (and other disadvantages suffered) because the employee has to temporarily live away from their usual place of residence for employment purposes. Additional expenses do not include expenses the employee would be entitled to claim as an income tax deduction. In addition to actually living away from the usual place of residence, the employee must be required to do so. For example, an allowance paid to an employee who lived about 60 km from his place of employment, but was not required to reside in accommodation closer to his work in order to carry out his employment duties, did not constitute a LAFHA even though he was living away from his usual place of residence and was compensated by the employer for so doing (Compass Group (Vic) Pty Ltd (As Trustee For White Roche & Associates Hybrid Trust) v FC of T 2008 ATC ¶10-051). Generally, the taxable value of a LAFHA benefit is the amount of the allowance that exceeds the amount reasonably necessary to compensate the employee for the cost of the accommodation away from home and for increased expenditure on food (¶3-450). Property fringe benefits If an employer, or a third party under an arrangement with an employer, provides a property benefit to an employee either for free or at a discount, a property fringe benefit arises (FBTAA s 40). For FBT purposes, property can be tangible property (eg goods, clothing, animals, gas and electricity) or intangible property (eg real property such as land and buildings), but does not include a right arising under a contract of insurance or a lease or licence in respect of real property or tangible property. Generally, the taxable value of the benefit is the amount by which the arm’s length cost of the goods to the employer exceeds the price charged to the employee. If, however, the property provided is of a kind normally provided as part of the employer’s business, concessional rules apply (¶3-445). A property fringe benefit can also cover the payment of money, other than salary or wages, by an employer to the trustee of a trust in respect of the employment of an employee (ID 2007/204). Although money is property under the FBTAA, it is not tangible property but is intangible property (FBTAA s 136(1); ID 2010/151). The provision of bitcoin by an employer to an employee in respect of their employment is a property fringe benefit (Taxation Determination TD 2014/28). Bitcoin is not tangible property for the FBT purposes and bitcoin holding rights are not a chose in action. However, as the definition of “intangible property” includes “any other kind of property other than tangible property”, bitcoin falls within the definition. The provision of bitcoin by an employer to an employee is therefore a property benefit. As bitcoin is not money but is considered to be property for tax purposes, it satisfies the definition of a “non-cash benefit” and is excluded from PAYG withholding. Exclusion from PAYG withholding means that bitcoin is not “salary or wages” (see the definition of fringe benefit in the FBTAA). Other examples of property fringe benefits are:

• an employer’s contributions to a redundancy fund on behalf of employees. (In Caelli Constructions (Vic) Pty Ltd 2005 ATC 4938, the fund’s trust deed fixed the weekly amount of the contributions to be made by employers for each worker, determined how the contributions were to be applied, and provided that the amount standing to the credit of a particular worker’s account was available for distribution to the worker if the employment ceased.) • a payment by an employer to the trustee of a trust or a non-complying superannuation fund set up to provide benefits to employees (Taxation Ruling TR 1999/5: ¶3-100). Employee benefits trusts Where bonus units are issued to employees as part of an employee benefits trust arrangement, the bonus unit received by the employee or a transfer from the employer contribution/unallocated trust capital account to the employee’s bonus unit account is a “non-cash benefit” (under ITAA97 s 995-1(1)) and is not the employee’s “salary or wages” (¶3-600). Such a bonus unit will be a fringe benefit provided to the employee, as summarised below (TR 2010/6): • the issue by the trustee of the bonus unit is the provision of a fringe benefit to the employee • alternatively, the transfer from the employer contribution/unallocated capital trust capital account on or after the issue of a bonus unit is the provision of a fringe benefit to the employee • additionally, where there are further such transfers to the employee’s bonus unit account in relation to bonus units that were previously issued for value and/or were subject to such previous transfers, there is a provision of a fringe benefit to the employee at the time of transfer. The benefit constituting the issue of a bonus unit is a property benefit (FBTAA s 40) that is an external property fringe benefit with a taxable value determined under FBTAA s 43. The benefit constituting the transfer from the employer contribution/unallocated trust capital account is either a property benefit or a residual benefit (FBTAA s 45; John Holland Group Pty Ltd & Anor v FC of T 2014 ATC ¶20-479: provision of flights under FIFO arrangements). The issue of a bonus unit to an employee by the trustee or the transfer from the employer contribution/unallocated trust capital account to the employee’s bonus unit account under the employee benefits trust arrangement is a benefit provided by the trustee under an “arrangement” (¶3-100) in respect of the employment of the employee (TR 2010/6). Example An employer contributes $100,000 to an employee benefits trust in a financial year and the trustee of the employee benefits trust selects employee E as an employee participant. The trustee loans $100,000 to Eliza (an employee), who pays $100,000 to the trustee and receives 100,000 $1 ordinary units. Shares in the employer have a value of $20 per share at the end of the financial year. The trustee uses the $100,000 received from Eliza to purchase 5,000 shares in the employer. The trustee allocates the 5,000 employer shares to Eliza’s ordinary units. In a subsequent year, the trustee issues 1,000 bonus units to Eliza at the employer’s request. The bonus units issued to Eliza are funded out of the employer contribution to the trust, and they give Eliza a share of the income of the trust and a proportionate interest in the assets of the trust. Eliza has received a non-cash benefit which is not “salary or wages”. The benefit constituting the issue of bonus units is a property benefit under s 40, and is an external property fringe benefit with a taxable value of $100,000 under s 43. Alternatively, Eliza has received a benefit in the trust fund constituted by the monies transferred from the employer contribution/unallocated trust capital account. This benefit is a property benefit under s 40, and is an external property fringe benefit with a taxable value of $100,000 under s 43.

By contrast, employer contributions made by an employer to an industry welfare trust (Class Ruling CR 2004/76) and contributions of apprentice levies to a redundancy fund (Class Ruling CR 2004/97) do not give rise to a fringe benefit. See also Class Ruling CR 2004/113 dealing with payments for worker income protection and portable sick leave insurance policies. Exempt property benefits Goods supplied to, and consumed by, an employee on a working day and on the employer’s premises, or

on premises of a related company, are an exempt property benefit. Examples are morning and afternoon teas provided to employees and food and drinks provided on the employer’s premises through a dining card facility (FBTAA s 41). Under such “meal card” arrangements, an employer pays for an employee’s meals provided by an independent caterer located on the employer’s premises (or that the independent caterer delivers to the employer’s premises). This effectively allows an employee with a meal card to purchase food and drink out of pre-tax income, whereas most employees must purchase their meals from after-tax income The s 41 exemption for property benefits consumed on the employer’s business premises on a working day does not cover food or drink provided to an employee under a salary sacrifice arrangement (see below). Property fringe benefits arising from contributions that an employer makes to worker entitlement funds are exempt from FBT, provided the conditions are met (¶3-600). The provision of a property benefit (or an expense payment benefit or a residual benefit) in respect of an “eligible work-related item” is an “exempt benefit” (¶3-600). Property benefits arising from providing non-entertainment meals to an employee employed in a primary production business located in a remote area are exempt benefits (¶3-700). Meal and other entertainment benefits A fringe benefit may arise in the form of a meal entertainment fringe benefit or an entertainment benefit provided by employers. Provision of “meal entertainment” is a reference to the provision of entertainment by way of food or drink, or accommodation or travel in connection with or to facilitate such entertainment, or connected reimbursements (s 37AD; ID 2014/15: expense incurred in providing the employee with travel includes reimbursements of an employee’s car parking fees). A meal entertainment benefit therefore arises if an employer provides an employee with entertainment by way of (or in connection with) food or drinks, but not entertainment by way of recreation. If a meal entertainment fringe benefit does not arise, then, depending on the circumstances, the entertainment benefit may be: • an expense payment benefit, eg reimbursement of entertainment expenditure incurred on an employee’s personal credit card to the extent that the entertainment was provided to employees or their associates • a property benefit, eg an entertainment meal provided in a restaurant to an employee • a residual benefit, eg use by an employee of sporting facilities owned by an employer • a board fringe benefit, eg an entertainment meal provided to an employee who is entitled under an industrial award to accommodation and at least two meals per day, or • a tax-exempt body entertainment benefit, eg the provision of an entertainment meal to an employee by an employer which is a tax-exempt body (see below). There are two methods for calculating the taxable value of meal entertainment fringe benefits — the 50/50 split method (ie 50% of the expenses incurred) or the 12-week register method (not applicable to salary packaged meal entertainment or entertainment facility leasing expenses, see below). The taxable value of an entertainment benefit provided by a tax-exempt employer is the expenditure incurred in providing the entertainment to the employee concerned. Where the employer elects to use the 50/50 split method, the minor benefits exemption cannot apply to reduce the taxable value of the meal entertainment fringe benefits. This is because under FBTAA s 37BA, the total taxable value of meal entertainment fringe benefits of the employer for the FBT year is 50% of the expenses incurred by the employer in providing meal entertainment for the FBT year. However, if the employer uses the 12-week register method, any minor benefits will reduce the total value of the meal entertainment fringe benefits that are used for the calculation under FBTAA s 37CB, because the minor benefits, while being meal entertainment, are not fringe benefits (TR 2007/12, para 262–265). Entertainment provided to an employee or to an associate of an employee by an income tax-exempt

employer, which is provided in respect of employment, is a tax-exempt body entertainment benefit if the expenditure would be non-deductible were the body a taxable entity (s 38; see also ATO Fact Sheet FBT and Christmas parties). Such a benefit will generally be a fringe benefit subject to FBT. Salary packaged meal entertainment and entertainment facility leasing expenses From 1 April 2016: • all salary packaged meal entertainment and entertainment facility leasing expenses are reportable and must be included on an employee’s payment summary where they exceed the reporting taxable value threshold of $2,000 (¶3-155), and • the 50/50 split method and 12-week register method cannot be used for valuing salary packaged meal entertainment or entertainment facility leasing expenses. The above rules apply to entertainment by way of food or drink, accommodation or travel in connection with, or to facilitate the provision of, such entertainment, and entertainment facility leasing expenses. Entertainment facility leasing expenses are expenses incurred in hiring or leasing: • a corporate box • boats or planes for providing entertainment, and • other premises or facilities for providing entertainment. Leasing expenses do not include expenses attributable to providing food or beverages or expenses attributable to advertising that would be an income tax deduction (ID 2009/141: meaning of the term “facility” in the definition of “entertainment facility leasing expenses”). Airline transport fringe benefits Airline transport fringe benefits may arise when an employee of an airline or travel agent is provided with free or discounted airline travel, subject to stand-by restrictions. Free or discounted air travel that is not subject to such restrictions is a residual fringe benefit (see below). From 8 May 2012, an airline transport fringe benefit is defined as an in-house fringe benefit or an in-house residual fringe benefit to the extent that it relates to the provision of airline transport and incidental services (FBTAA s 136(1)). An airline transport benefit is taxed as an in-house residual fringe benefit to the extent that the benefit includes the provision of transport in a passenger aircraft operated by a carrier (including any related incidental services on board the aircraft) and is subject to the stand-by restrictions that customarily apply in the airline industry. The rules for calculating the taxable value of an airline transport fringe benefit (previously in FBTAA Pt III Div 8) are now aligned with the general provisions dealing with in-house property fringe benefits and inhouse residual fringe benefits (see ¶3-445). Board fringe benefits A board fringe benefit consists of any meal provided to an employee who is entitled to at least two meals a day and accommodation under an industrial award or an employment arrangement (where certain conditions are also met). The taxable value of a board benefit is $2 per meal per person ($1 where the recipient is under 12 years old). Exempt board benefits The following meals are not board fringe benefits (but may be property fringe benefits or, if provided by a tax-exempt body, tax-exempt body entertainment fringe benefits): • meals provided at a party, reception or other social function • meals provided in a dining facility open to the public, except for board meals provided to employees of a restaurant, motel, hotel, etc, and

• meals provided in a facility principally used by a particular employee. Incidental refreshments (eg morning and afternoon teas) supplied as part of board are exempt from FBT. Board meals provided to an employee who is employed in a primary production business located in a remote area are exempt benefits. Residual fringe benefits A fringe benefit which is not covered by a specific fringe benefit or valuation rule may be a residual fringe benefit. It must be possible to identify the benefit which is provided in connection with the employment relationship (FBTAA s 45). For example, a loan establishment service provided by a bank to an employee without charge, being a service for which the bank charges customers, gives rise to a residual benefit (Westpac Banking Corporation v FC of T 96 ATC 5021) (ID 2006/159: payment for the funeral expenses of a deceased employee is not a residual fringe benefit). The decision in ID 2006/159 could equally apply in circumstances where the benefit was an expense payment or property benefit that relates to funeral costs of a deceased employee, but not where an immediate member of an employee’s family has passed away (NTLG FBT minutes, February 2012). A residual fringe benefit can also arise where an employee is entitled to use a motor vehicle other than a car (eg a motorcycle), subject to certain exemptions (for the ATO compliance approach, see Practical Compliance Guideline PCG 2018/3). The exemption is subject to certain private use restrictions and excludes vehicles used for taxi travel (other than a limousine) and most cars (FBTAA s 47(6); ID 2010/163: use of a tram). Where an employee only travels between home and work on a bus owned by the employer under an employment arrangement, this constitutes a residual benefit which is an exempt benefit under s 47(6) (ID 2009/140). A residual benefit that arises from the participation of an employee in a fitness class provided by an employer on the employer’s premises is not an exempt benefit under FBTAA s 47(2) if the benefit provided to the employee is the participation in a fitness class, and not the provision, or use, of a recreational facility (ID 2015/25). Where property is also provided at the same time as a residual benefit (eg spare parts are provided when a television set is repaired), the two benefits are treated as one residual benefit if the provider is in the business of supplying such goods and services. If the goods are supplied by one provider and the services by another, the two types of benefit are valued separately. A residual benefit generally arises at the time when the benefit is provided. If the benefit is provided over a period, such as where an employee has the use of property for a period of time, the benefit arises during that period. If the period straddles more than one FBT year, the benefit is taxable on a proportional basis in each year. Generally, the taxable value of a benefit is the amount by which the arm’s length cost of the benefit to the employer exceeds the price charged to the employee. If, however, the property provided is of a kind normally provided as part of the employer’s business, concessional rules apply. The provision of a residual benefit (or an expense payment benefit or a property benefit) in respect of an “eligible work-related item” is an “exempt benefit” (¶3-800). Specific exclusions from the definition of “fringe benefit” are also discussed at ¶3-600.

CALCULATING FBT ¶3-300 How is the amount of FBT calculated? FBT is levied on the “fringe benefits taxable amount” of a fringe benefit provided by an employer in respect of an employee’s employment, ie the taxable value grossed-up by the relevant factor (see “Grossing-up rates” below). The FBT grossing-up process is designed to achieve equitable tax treatment between fringe benefits and cash salary for an employee at the top marginal rate of personal income tax by converting the fringe benefits to their gross or pre-tax equivalent value. The FBT payable is then

calculated by applying the FBT rate for the year to the tax-inclusive value of the fringe benefit, just as income tax is applied to gross salary or wages. FBT rate FBT year

FBT rate

Ending 31 March 2018, 2019, 2020 and 2021 47% Type 1 and Type 2 gross-up rates Under the GST regime, there are taxable supplies, GST-free supplies, input taxed supplies and GST credits (¶3-950). An employer’s cost of providing a fringe benefit will be reduced in cases where the employer is able to claim GST credits or no GST applies when purchasing the benefits provided. Therefore, to maintain tax neutrality for all types of benefits, two gross-up rates are used to determine the employer’s fringe benefit taxable amount: • a higher (Type 1) gross-up rate of 2.0802, where the employer (provider of the benefit) is entitled to claim GST credits at the time the benefit was acquired, and • a lower (Type 2) gross-up rate of 1.8868, where the employer did not incur GST or is not entitled to claim GST credits on the purchase of the benefits. The Type 1 gross-up factor effectively recovers the GST credits obtained by the employer in providing the fringe benefit. The supply of a fringe benefit in itself is not subject to GST. However, an employer may have to pay GST on any employee contribution to the cost of the fringe benefit provided (¶3-550). Steps to take in calculating FBT for an FBT year To determine the fringe benefits taxable amount for a year of tax, an employer may have to calculate two types of aggregate fringe benefits amounts. A Type 1 aggregate fringe benefits amount is the total taxable value of all fringe benefits provided to employees or their associates where GST credits are available to the employer (provider of the benefit). Any excluded fringe benefits with GST credits available to the employer are added to this amount. A Type 2 aggregate fringe benefits amount is the total taxable value of all fringe benefits provided to employees or their associates where either GST credits were not available to, or GST was not paid by, the employer. Essentially, the individual fringe benefits amount for Type 2 aggregate fringe benefits is the employer’s total individual fringe benefits amount reduced by the individual fringe benefits amount used in determining the employer’s Type 1 aggregate fringe benefits amount. The value of excluded fringe benefits can be calculated in a similar way. The steps for calculating the FBT payable on a benefit by an employer are as below: Step 1: For each employee, identify those fringe benefits that are “GST-creditable benefits”, ie benefits where the employer can claim GST credits. Work out the individual fringe benefits amount using the valuation rules applicable to the benefit. Step 2: Add all the individual fringe benefits amounts worked out in Step 1. Step 3: Identify the “excluded fringe benefits” (¶3-155) that are GST-creditable benefits and add up the taxable value of those excluded fringe benefits. Step 4: Add the totals from Steps 2 and 3. This is the Type 1 aggregate fringe benefits amount. Step 5: For each employee, identify those benefits that are not taken into account under Step 1. Work out the individual fringe benefits amount for each employee in relation to those benefits. Step 6: Add up all the individual fringe benefits amounts worked out in Step 5. Step 7: Identify the excluded fringe benefits that are not taken into account under Step 3 and add up the taxable value of those excluded fringe benefits. Step 8: Add up the totals from Steps 6 and 7. This is the Type 2 aggregate fringe benefits amount.

Step 9: Calculate the fringe benefits taxable amount by grossing-up the Type 1 aggregate fringe benefits (at the 2.0802 Type 1 gross-up rate) and the Type 2 aggregate fringe benefits (at the 1.8868 Type 2 gross-up rate) and add them together. Step 10: Apply the FBT rate (47%) to the fringe benefits taxable amount (the total in Step 9). This is the amount of FBT payable by the employer. Example An employer provides the following benefits to a single employee: • expense payments (GST taxable supplies where input tax credits are claimed) — $7,000 • remote area residential fuel (excluded fringe benefit where input tax credits are claimed) — $1,000 • expense payments (GST-free supplies, no input tax credit available) — $6,000 • remote area rent reimbursement (excluded fringe benefit, no input tax credit available) — $3,000. Calculate employer’s Type 1 aggregate fringe benefits amount Steps 1 & 2: Type 1 individual fringe benefit amount = $7,000. Step 3: Type 1 excluded fringe benefit amount = $1,000. Step 4: Employer’s Type 1 aggregate fringe benefits amount = $8,000. Calculate employer’s Type 2 aggregate fringe benefits amount Steps 5 & 6: Type 2 individual fringe benefit amount = $6,000. Step 7: Type 2 excluded fringe benefit amount = $3,000. Step 8: Employer’s Type 2 aggregate fringe benefits amount = $9,000. Calculate fringe benefits taxable amount by grossing-up Step 9: Type 1 amount from Step 4 × 2.0802, ie $8,000 × 2.0802 = $16,641. Step 9: Type 2 amount from Step 8 × 1.8868, ie $9,000 × 1.8868 = $16,981. Step 9: Total fringe benefits taxable amount = $33,622 (ie $16,641 + $16,981). Calculate FBT payable (Step 10) The FBT payable by the employer is: Total fringe benefits taxable amount × FBT rate $33,622 × 47% = $15,802

¶3-400 Calculating taxable values Each class of fringe benefits has its own specific valuation rules. Valuation rules are discussed for the following fringe benefits: • car benefits (¶3-410) • car parking benefits (¶3-420) • expense payment benefits (¶3-430) • loan benefits (¶3-440) • in-house benefits (¶3-445) • living-away-from-home allowance benefits (¶3-450). When calculating the taxable value, the value of the fringe benefit is the GST-inclusive value where applicable (¶3-950). Where the “otherwise deductible” rule applies (¶3-500), the taxable value is reduced by the hypothetical tax deduction to which the employee would have been entitled. Reduction in taxable value concession A number of fringe benefits also attract concessional treatment by way of a reduction in the taxable value

of the fringe benefit that results in a reduced amount of FBT, or even no FBT, being payable. Some of the benefits to which the reduction concession applies are discussed at ¶3-700. In some instances, special conditions must be satisfied for the concession to be available, for example, keeping certain records.

¶3-410 Car benefits A car benefit is the most common form of fringe benefit provided to employees. A car fringe benefit most commonly arises where a car that is held by an employer is made available for the private use of an employee (or an associate of the employee). A “car held by a person” refers to a car that the person owns, or leases, or that is otherwise made available to the person by another person. Private use arises if the car is actually used other than in the course of producing assessable income, or the car is garaged or kept at the employee’s residence, or the employee has custody and control of the car. Care should be taken as a car benefit can arise if, at all material times, a car is garaged or kept at or near a company taxpayer’s principal place of business, which is also the residential address of its sole director (Jetto Industrial Pty Ltd v FC of T 2009 ATC ¶10-090; [2009] AATA 374). This is the case even if the taxpayer inadvertently fails to lodge an FBT return on the mistaken belief that, because the car was 100% used for business purposes, there was no FBT liability and no requirement to lodge a return, or that no tax would have been payable in any case (whether the calculation method in FBTAA s 9 or 10 was used: see below) because the logbook and other evidence showed 100% business usage and therefore no car fringe benefit taxable value (Jetto Industrial Pty Ltd 2009 ATC ¶10-090; [2009] AATA 374). There are two methods of calculating the taxable value of car benefits — the statutory formula method and the operating cost method (FBTAA s 9, 10). Each method has its own record-keeping requirements. An employer can choose to use either method each year for each car giving rise to a car fringe benefit. The statutory formula method automatically applies if an employer does not make a choice. If an employer chooses to use the operating cost method for a particular car for any year, but the statutory formula would in fact result in a lower value for that year, the lower statutory formula value applies for the year (s 10(5)). Regardless of the method used, FBT is payable on the grossed-up taxable value of the benefit. Statutory formula method The statutory formula method applies a statutory fraction (based on kilometres travelled) to the base value of a car. Under this method, a percentage specified by law (statutory fraction) is applied to the base value of the car. The taxable value is calculated using the formula: A×B×C − E   D    where: A

is the base value of the car

B

is the statutory fraction (0.20 in all cases, applicable from 1 April 2014 onwards)

C

is the number of days in the FBT year when a car benefit was provided to an employee

D

is the number of days in the FBT year

E

is the amount of the recipients contribution (if any).

Base value The base value of a car is generally the cost price of the car (FBTAA s 9(2)(a)(i)). The cost price includes the cost of any non-business accessories fitted and delivery cost at the time of purchase, but excludes registration cost and stamp duty (FBTAA s 136(1)). Paint protection, fabric protection, rust protection and window tinting are each a “non-business accessory” (ID 2011/47). Taxation Ruling TR 2011/3 explains the meaning of “cost price” of a car in the following circumstances: • a trade-in vehicle is provided by an employee towards the purchase of a car

• an up-front cash payment made by an employee towards the purchase of a car, and • arrangements involving fleet discounts, sales incentives and manufacturers’ rebates. The base value is reduced by one-third if the employer has held the car for more than four years at the start of the FBT year. Example Assume that the car in the above example was purchased for $25,000 and was fitted with a car stereo (non-business accessory) costing $500. If 16,009 (annualised) kilometres were travelled, then the statutory fraction is 0.20. Assuming the recipient did not contribute to the provision of the vehicle, the taxable value is calculated as:

25,500 × 0.20 × 228  365 

−

$0

= $3,186

Operating cost method Under the operating cost method, the fringe benefits taxable value is calculated by totalling the costs of running and financing the vehicle. To use this method, adequate FBT records must be kept. The total cost is split between the business use portion and the non-business use portion. The non-business use portion becomes the taxable value of the fringe benefit, as calculated using the formula below: (C × (100% − BP)) − R where: C BP R

is the operating cost of the car during the holiday period is the business use percentage applicable to the car for the holding period, and is the amount of any recipients payment for the holding period.

The holding period refers to the period during the year in which the provider held the car for the purpose of providing the fringe benefit. The operating cost of the car includes: • where the car is owned — depreciation and imputed interest cost on the value of the car and any nonbusiness accessories fitted to the car • where the car is leased — the lease costs • expenses incurred on repairs, maintenance and fuel (ID 2014/18: car expense includes the cost of a map update of an in-built satellite navigation system that is part of the car), and • insurance and registration costs. Where the employer owns the car, depreciation and imputed interest are calculated on the car. Depreciation is calculated using the following formula: A×B×C  D    where: A

is the depreciated value of the car

B

is deemed depreciation rate (25% for cars acquired on or after 10 May 2006)

C

is the number of days during the year the provider held the car, and

D

is the number of days in the year.

Imputed interest is calculated using the following formula: A×B×C  D    where: A

is the depreciated value of the car

B

is the statutory or benchmark interest rate (4.8% for the 2020/21 FBT year)

C

is the number of days the provider held the car, and

D

is the number of days in the year.

The imputed interest is calculated separately on non-business accessories such as CD players and fitted air conditioners. The benchmark interest rate is 4.8% for the 2020/21 FBT year (the same rate as that used to calculate the taxable value of a loan fringe benefit: ¶3-440). The business use percentage is the percentage of the total distance travelled by the car relating to business use. The business use percentage is calculated using the following formula: number of business km travelled by car during holding period ×    total number of km travelled by car during holding period 

100%

Logbook and odometer records showing the business use of the car should be maintained. The logbook must be kept for the first year in which the operating cost method is used and must be updated every five years. The logbook must be kept for a minimum of 12 weeks. An entry must be made to record each business journey. Private journeys do not have to be recorded. The details for each journey include the dates the journey began and ended, the relevant odometer readings and the journey’s purpose. A journey between home and work will generally not be a business journey. However, travel from home will be a business journey where: • it involves travel to a client’s or customer’s premises and then to work • employment actually starts prior to leaving home, eg a doctor (see also MT 2027 private use of car: home to work travel). Recipient’s payment The taxable value is reduced by contributions made by the employee towards the cost of the benefit. Example Assume a car has been leased with a yearly lease payment of $6,000. Repairs, maintenance and fuel costs for the year amount to $2,500 and insurance and registration costs amount to $1,000. The business use percentage of the car was 50%. Assuming the employee did not contribute towards the cost of the vehicle, the fringe benefits taxable value is:

($9,500 × 50%) − $0 = $4,750

Exemptions Where an employee is provided with a car expense payment fringe benefit (eg the provision of fuel), in respect of the car fringe benefit, the provision of the car expense payment fringe benefit is an exempt benefit. Statutory formula v operating cost The question of whether to use the statutory formula or operating cost method will depend on many factors, including the pattern of use of the car and the number of kilometres travelled. If the car travels

relatively few kilometres in a year, the operating cost method may provide a lower fringe benefits taxable value (note that the distance travelled factor is irrelevant under the 20% flat rate basis, see above). However, detailed records must be kept for the operating cost method. The operating cost method may also provide a lower fringe benefits taxable value if the business use percentage is relatively high, so it is necessary to weigh up the full range of factors when deciding which valuation method to use. For guidelines, see the ATO’s “FBT — car calculator” (available at ato.gov.au/Calculators-and-tools/FBT--car) which is designed to help employers calculate the taxable value of a car fringe benefit using either the statutory formula or operating cost method. It does not calculate the grossed-up value of the benefits or the tax payable. Luxury cars lease arrangements The FBT treatment of luxury cars is the same as for other cars. However, the limits on the amount of depreciation or lease payments that may be claimed on luxury car leases for income tax purposes has made salary packaging of luxury cars less tax attractive. The treatment of luxury cars as part of a salary package is discussed at ¶10-310. Novated lease arrangements A novated lease is a tripartite arrangement between an employer, an employee and a finance company (as a lessor) under which the obligation to make the lease payments to the lessor is transferred from the employee to the employer while the employee remains with the employer. Novated leases and a related arrangement known as an associate lease are useful tools for salary packaging and are discussed in ¶10310. Full novation In full novations, the lease obligations are transferred to the employer who becomes the lessee. There are no income tax consequences for the employee during the period the employer makes the lease payments. The employer is entitled to a tax deduction for lease expenses where the vehicle is used in the business or provided to an employee as part of salary packaging. For a luxury car, the deduction is based on an accrual amount for finance charges and depreciation (subject to the car depreciation limit, see above). A car fringe benefit arises where the car is provided for the private use of the employee or employee’s associate. Partial novations For partial novations, the income and FBT consequences are as follows. The employee is assessable on the benefit received as sub-lessor at the time the lease payment obligations are transferred under a partial novation. The income or benefit is calculated by reference to the value, equivalent to the lease payments, of the consideration received. That consideration is the promise by the employer to make rental payments directly to the financier in lieu of payments to the employee under the sub-lease between the employer and the employee. A tax deduction is not available to the employee in non-luxury motor vehicle partial novations where the lease payments are contractually made by the employer directly to the finance provider. In these circumstances, the employee no longer has the contractual obligation for the lease payment liabilities and does not make the payments. For a partial novation involving a luxury motor vehicle, the employee is the notional owner as sub-lessor in the sub-lease between the employee and employer. The employee is assessed on the accrual amount of the notional loan in the luxury motor vehicle novation. The accrual amount is calculated by reference to the consideration (ie the employee granting to the employer the right to possession or use of the motor vehicle) based on the amount of the lease payment obligation transferred to the employer. A deduction is not available to the employee in a luxury motor vehicle partial novation. An employee, as sub-lessee, can claim a deduction only to the extent to which a deduction is allowable to the lessee under other provisions of ITAA97. In partial novations, a residual benefit may arise where all that occurs is the transfer to the employer of the lease payment obligations of the employee. A car benefit arises where the employer provides the car

for the private use of the employee or associate of the employee. Private use of a motor vehicle other than a car Where an employee is entitled to private use of an employer’s motor vehicle other than a car (eg a motorcycle), this gives rise to a residual benefit (FBTAA s 45: ¶3-200). A number of acceptable methods may be used to determine the taxable value of the benefit, such as the operating cost method based on the number of private kilometres travelled or other reasonably based approach (Miscellaneous Taxation Ruling MT 2034). One acceptable method is to value the net benefit of the private use of the vehicle by multiplying the number of private kilometres travelled by the employee during a year by a cents per kilometre rate (see table below). This method can only be used where there is extensive business use of the vehicle (MT 2034, para 15–16).

Motor vehicle (other than a car) — cents per kilometre rate Engine capacity/type

Rate per kilometre

Up to 2500cc

56 cents

Over 2500cc

67 cents

Motorcycles

17 cents

¶3-420 Car parking fringe benefits A car parking fringe benefit arises where an employer provides a car parking facility for an employee and all of the following conditions are satisfied: • The car is parked on business premises (which may itself be a commercial car parking station) that is within one kilometre of a commercial car parking station which is a permanent commercial parking facility open to the public for all-day parking for a fee of at least $9.15 a day for the 2020/21 FBT year (up from $8.95 a day for 2019/20) (see example and explanations below). • The car is parked there for more than four hours between 7 am and 7 pm on the particular day. • The car parking is provided in respect of the employee’s employment. • The employee has parked at or near the employee’s primary place of employment. • The car is used by the employee to travel between the employee’s residence and the primary place of employment (FBTAA s 39A). Example Three commercial parking stations are located within 1 km of an employer-provided car park where the lowest fee charged by each of the operators on 1 April 2020 is $10.50, $10.00 and $9.50. The condition in the first dot point is satisfied because the lowest fee charged by one of the operators is higher than the car parking threshold ($9.15 for the 2020/21 FBT year).

A “commercial parking station” in relation to a particular day means a permanent commercial car parking facility where any or all of the car parking spaces are available in the ordinary course of business to members of the public for all-day parking on payment of a fee, but not a parking facility on a public street, etc, paid for by inserting money in a meter or by obtaining a voucher (Virgin Blue Airlines Pty Ltd v FC of T 2010 ATC ¶20-226; Draft Taxation Ruling TR 2019/D5, see below). “All-day parking”, in relation to a particular day, means parking of a single car for a continuous period of six hours or more during the period between 7 am and 7 pm (the daylight period) on that day. A fee charged by the operator of a commercial parking station for vehicles entering the station from 1 pm is not a fee for “all-day parking” as, after 1 pm, it is not possible to park for a continuous period or six hours of

more during a daylight period on that day as that period ends before 7 pm for that day (ATO ID 2014/12). In FC of T v Qantas Airways Ltd 2014 ATC ¶20-477, the Full Federal Court held that the employer (taxpayer) was liable to pay FBT in respect of car parking facilities provided to its employees at all major airports around Australia, including the Canberra airport. As part of their remuneration, Qantas employees working at various airports were provided with car parking spaces, either at the taxpayer’s own premises at the airports or in the vicinity of the premises where the staff worked. The Qantas case examined the issue whether the car parking spaces provided constituted a car parking benefit under s 39A. That is, whether there were commercial parking stations located within a one kilometre radius of the premises where the cars were parked where the lowest fee charged for all-day parking exceeded the relevant car parking threshold (see s 39A(1)(a)(ii) and (iii)). The taxpayer argued that the parking facilities available at the airports were not “commercial parking stations”, but the court held that the requirement that there be a commercial parking station within a one kilometre radius was a trigger for liability to the tax. It was a mechanism to determine which car spaces provided to employees were sufficiently valuable such that they should be assessed with FBT. There was no ambiguity about the word “public” and the meaning of “commercial parking station” was clear. The court also rejected the Administrative Appeals Tribunal’s (AAT’s) finding that the Canberra airport car parking facilities were not a “commercial parking station”. The presence of a qualifying parking station was not directed to the issue of whether employees could find alternative parking, but whether the employer-provided parking spaces had a value that was to be assessed under the FBTAA. Draft Taxation Ruling TR 2019/D5 provides guidance on the meaning of “commercial parking station” and the provision of a car parking fringe benefit in the FBTAA. The final ruling will update former Taxation Ruling TR 96/26 on car parking fringe benefits (withdrawn on 13 November 2019) to reflect contemporary commercial car parking arrangements and legal developments, including the Virgin and Qantas decisions. When the final ruling is published, any changes in view from former TR 96/26 will apply from 1 April 2021 (www.ato.gov.au/General/ATO-advice-and-guidance/Advice-under-development-program/Advice-underdevelopment---FBT-issues/; ATO private ruling Authorisation Number: 1051590502756, 21 November 2019). Taxable value of a car parking fringe benefit In determining the taxable value of a car parking fringe benefit, it is necessary to calculate the fringe benefits taxable value of each benefit and the number of car parking fringe benefits provided to employees (or associates). The three methods of calculating the taxable value of a single car parking fringe benefit are as follows: (1) The commercial car parking station method — under this method, the taxable value is the lowest public parking fee charged for any continuous period of six daylight hours in the ordinary course of business by any commercial car parking station within one kilometre of the business premises, reduced by any amount contributed by the employee. (2) The market value method — under this method, the taxable value is effectively the market value of the benefit provided reduced by any employee contribution. The relevant market value is to be determined by a qualified arm’s length valuer and must be reported to the employer in an approved form. (3) The average cost method — under this method, the taxable value is the average of the lowest fees charged by a commercial parking station within one kilometre of the business premises on the first and last days of the FBT year on which a car parking benefit is provided to an employee (or associate). The lowest fee must be representative, ie it cannot be substantially greater or less than the average daily fee charged for the four weeks before or after that particular day in the FBT year. In calculating the number of car parking fringe benefits provided (so as to determine the taxable value of all car parking fringe benefits for the year), an employer can keep detailed records of each car parking benefit provided or, alternatively, adopt either: • the statutory formula method, or • the 12-week record-keeping method.

Statutory formula method Under this method, the taxable value is calculated according to the following formula: daily rate amount × number of days in availability period × 228  365  The daily rate amount is the value of the benefit provided as determined under the commercial car parking station method, market value method or average cost method. To calculate the number of days in the availability period the employer must also record the number of car parking spaces available over the FBT year. Where the average number of employees covered by this method is less than the average number of spaces provided, the taxable value of the benefits is reduced proportionately. 12-week record-keeping method Under this method, the total taxable value of car parking benefits provided during the full FBT year is based on the value of benefits provided in a 12-week period. The employer must keep a register to record the details of the benefits provided during that period. The total taxable value is then determined according to the following formula: taxable value of parking benefits ×

52 ×  12 

number of days of car parking benefits  365 

The taxable value of each benefit provided during the 12-week period must be determined under the commercial car parking station method, the market value method or the average cost method. The 12week period must be representative of car parking usage over the year and a new register must be kept after four years or in the following year where the number of spaces increases by more than 10% on any day. Which valuation method to use? In calculating the taxable value of car parking fringe benefits, the commercial car parking station and average cost methods are the simplest as the market value method requires an independent valuation which makes it more complex. In calculating the number of spaces provided during the year, the statutory formula method is the simplest. However, depending on the number of spaces actually provided, the 12-week register method may provide a lower overall fringe benefits taxable value.

¶3-430 Expense payment benefits An expense payment fringe benefit arises where an employer pays or reimburses expenses incurred by an employee. A reimbursement generally requires an employee to be compensated exactly for an expense already incurred (¶3-200). The taxable value of an expense payment fringe benefit is generally the amount which is paid or reimbursed by the employer for the expenses incurred by the employee (FBTAA s 23). The valuation is different where the expense is incurred in respect of purchasing goods or services which the employer normally purchases or produces for sale to the public, or which are similar to those the employer normally supplies to the public, where concessional rules for in-house benefits may apply (¶3-445). The taxable value of the expense payment benefit may be reduced where the employee could receive an income tax deduction (¶3-500), or where it relates to certain remote area housing allowances. For example, an employer pays an employee’s home telephone bill of $1,200 for the FBT year and the employee declares that 50% of the bills are for business purposes and are therefore otherwise deductible, while the other 50% is for private calls. The expense payment would be $600 (ie 50% of $1,200). Where an employer pays amounts which have been salary sacrificed by an employee to the trustee of a trust as repayments of principal on an interest-free loan, each payment made by the employer to the trustee is taken to constitute the provision of an expense payment benefit by the employer to the

employee (FBTAA s 20). The taxable value of the external expense payment fringe benefit is the amount of the loan repayment (FBTAA s 23). This value is not reduced by the deductible rule (¶3-500) as each repayment on the loan is a repayment of principal on an interest-free loan and the employee would not have been entitled to an income tax deduction had the employee incurred and paid these amounts (ID 2011/54). Employee loans and employee share trust schemes An expense payment fringe benefit may arise where an employer pays a liability owed by an employee to a third party. However, FBT does not apply to money or property acquired by a valid employee share trust (EST), as the employee is taxed on their employee share scheme interests in the EST pursuant to Div 83A and Subdiv 130-D of the ITAA97 (ID 2010/108: what constitutes a valid EST under ITAA97 s 13085(4)). Taxpayer Alert TA 2011/5 warns about avoidance arrangements with features substantially equivalent to the following: • An employer establishes an employee benefit arrangement which operates through an employee share trust (EST), and makes a loan contribution to the trust. • The trustee of the trust uses the funds to provide interest-free loans to one or more employees and the employees use the borrowed funds to acquire units in the trust. • The trustee invests in the employer by acquiring shares and notionally allocates those shares to the units. • The employees enter into an effective salary sacrifice arrangement (SSA) with the employer. • The employer provides a benefit to employees, by paying salary sacrificed amounts to the trustee as repayments of the employee loans. In turn, the employee makes loan repayments to the employer. • The employer does not appear to include the taxable value of the benefit provided in its FBT liability (see diagram below).

The ATO considers that such an arrangement gives rise to taxation issues that include whether: • the trust can be a valid EST where it engages in activities which are not merely incidental to the activities set out in the definition of EST in s 130-85(4) (see ID 2010/108)

• an effective SSA has been entered into in accordance with TR 2001/10 • repayments made by the employer to the trustee, are an expense payment fringe benefit under FBTAA s 20, and FBTAA s 24 applies to reduce the taxable value to nil under the otherwise deductible rule • the employer is required to include the taxable value of an expense payment fringe benefit in their fringe benefits taxable amount for the purpose of determining the employer’s FBT liability under FBTAA s 66, and • the anti-avoidance provision in s 67 of the FBTAA may apply to the arrangement. Employment remuneration trust arrangements Taxation Ruling TR 2018/7 provides guidelines on how the tax laws apply to an employee remuneration trust (ERT) arrangement that operates outside of ITAA97 Div 83A (about employee share schemes: (¶3600). It applies to all Australian resident employers, employees and trustees who participate in an “ERT arrangement” involving a trust established to facilitate the provision of payments and/or other benefits to employees (for examples of ERT arrangements, see TR 2010/6 and TD 2010/10). The key points in TR 2018/7 for FBT purposes are noted below. When is a contribution a fringe benefit? A contribution made by an employer to the trustee is a fringe benefit where the trustee is an associate of an employee and the contribution is a benefit provided in respect of the employment of a particular employee, or two or more employees. “In respect of employment” requires a sufficient or material, rather than a causal, connection or relationship between the benefit and the employment (see Indooroopilly’s case: ¶3-100). A contribution is not a fringe benefit if it is a payment of salary or wages or a deemed dividend under ITAA36 Div 7A. Where a contribution is made for a particular employee (rather than employees generally), s 109ZB(3) will apply to prevent a contribution being a deemed dividend, and FBT will apply. Investing the contribution and providing benefits to employees from the ERT Where, under an arrangement with the employer, the trustee applies the contribution to make loans to employees, the employer will be taken to have provided a loan fringe benefit. The taxable value of a loan fringe benefit may be reduced by the “otherwise deductible” rule in FBTAA s 19 only where (and to the extent) there was a reasonable expectation of sufficient income had the employee used the loan for an attended purpose. There will not be a reasonable expectation of sufficient income where: the employee’s right to income of the ERT (see TD 2018/9) is at the discretion of the trustee; the entitlement to income is fixed over a finite period which, when compared to the interest expense, has no obvious commercial justification; the connection with assessable income is remote or insufficient; or no assessable income (other than capital gains) is expected to be generated (see TR 95/33). Example: No reduction in taxable value of a loan fringe benefit where there is no expectation of dividend income Tom, an employee, uses a loan from the trustee to acquire an interest in the ERT pursuant to an arrangement between the ERT trustee and Tom’s employer. The trustee in turn uses the loan funds to acquire shares in the employer (ABC Pty Ltd). However, the shares in ABC Pty Ltd are unlikely to pay dividends over the ensuing three-year period. Under the plan rules, Tom must hold the trust interest for a three-year period, after which time the interest in the ERT will be automatically redeemed and the loan repaid. The trust interest is unlikely to generate any trust income for Tom over the three-year period but will most likely deliver a sizeable capital gain to the employee on disposal of the trust interest. This is because the business is currently in a start-up phase and it is expected that the share value in ABC Pty Ltd will begin to achieve significant growth after the first two years of operations. In this situation, the otherwise deductible rule would not apply to reduce the taxable value of the loan fringe benefit because the interest in the trust is not likely to generate any trust income over the holding period. The same result would arise if, in lieu of shares, the trustee was acquiring rights to shares.

How are benefits assessed to the employee? Where a benefit received by an employee from the trustee is a fringe benefit, it is non-assessable non-

exempt income of the employee (ITAA36 s 23L). Exempt expense payment benefits There are a number of exempt expense payment fringe benefits. Any expense payment fringe benefit which is covered by a no-private-use declaration is exempt. A no-private-use declaration is made by an employer who only pays for or reimburses so much of an expense that would not attract FBT. An accommodation expense payment fringe benefit will be exempt where the benefit is provided to employees solely because they are required to live away from their usual place of residence to perform employment duties, but not where the employee is undertaking travel for employment purposes, eg overnight hotel accommodation. Where an employee is provided with a car expense payment fringe benefit, it will be exempt if the car is not leased to the employee by the provider of the benefit and the reimbursement is calculated by reference to the distance travelled by the car (¶3-410). An expense payment benefit cannot be in relation to certain types of activities such as holidays, attending medical examinations, relocating or attending an employment interview. Laptop computers — overlap with exempt benefit rule The provision of an expense payment benefit, a property benefit or a residual benefit in respect of an “eligible work-related item” is an “exempt benefit” (¶3-800). The provision of a laptop, notebook or portable computer is not an exempt benefit if, earlier in the FBT year, an expense payment benefit or a property benefit of the employee has arisen in relation to another one of these computers. Credit card use by employees Where an employer pays or reimburses an employee’s credit card account that has been used by the employee, the payment will be an expense payment fringe benefit if it is part of an effective salary sacrifice arrangement (TR 2001/10). This will be the case regardless of the items of expenditure incurred under the credit card agreement, ie purchases of goods, services or cash advances. Where the expenditure incurred by the employee is the amount outstanding as a debt to the credit provider, the payment or reimbursement would not be salary or wages. The ATO’s view is that a cash advance on a credit card does not prevent an employer making a payment or reimbursement in relation to the credit card outstanding balance. However, where there is an employer and employee agreement, arrangement or understanding in place that permit regular cash advances (eg $X weekly), the ATO would review such arrangements. If an employee uses the cash advance money to purchase a meal, the expense payment benefits relating to cash advances on the credit card is not in relation to “meal entertainment” (for the purposes of FBTAA s 37AD), but relate to the outstanding balance on the credit card account. Where an employer provides an expense payment benefit which includes some reference to cash advances on a credit card facility, the payment or reimbursement is not in relation to expenses incurred in providing entertainment by way of food or drink. Any connection as to how the cash advance funds were used by the employee is too remote to satisfy the requirements of s 37AD.

¶3-440 Loan fringe benefits A loan fringe benefit arises where an employer makes a loan to an employee (s 16, 17, 147, 148). Loans include those made by an employer’s associate, or by a third party under an arrangement with an employer, and loans to an employee’s associate or to some other person at the employee’s or associate’s request (ID 2003/315 and ID 2003/347). The loan fringe benefit exists for as long as any part of the loan remains unpaid. A loan of property is generally valued as a residual benefit (¶3-200). A loan fringe benefit also arises where an employer allows a debt owed by an employee to run past the due date for payment and exists for as long as the debt remains unpaid (s 16(2)). If any part of a loan is waived, a debt waiver fringe benefit arises (¶3-200). A loan fringe benefit also arises where a financial institution offers an arrangement which is materially different to that offered to other customers. A loan includes an advance of money, the provision of credit,

or any other transaction that in substance effects a loan. Once interest has accrued for six months on such a loan, there is deemed to be a separate and additional interest-free loan of the accrued unpaid interest. A statutory or benchmark interest rate of 4.80% for the 2020/21 FBT year (reduced from 5.37% for the 2019/20 FBT year) is used to calculate the taxable value of a loan fringe benefit. The benchmark interest rate is the same rate as that used to calculate the taxable value of a car fringe benefit where an employer chooses to value the benefit using the operating cost method (¶3-410). The taxable value of a loan fringe benefit is the difference between the interest accruing on the loan and the amount of interest calculated with reference to the statutory benchmark rate of interest. If the interest accruing on the loan is at least as great as the notional interest based on the benchmark rate, then the taxable value of the loan benefit is nil. The taxable value of the loan may be reduced where an employee uses all or part of the loan for incomeproducing purposes (see Example 1 below). For loans other than car loans, the starting point for determining the amount of the reduction is to calculate the amount of the notional tax deduction available to the employee. Where the loan is used to purchase a car, the deductible percentage of interest depends on the percentage of business use of the car during the year. To establish that interest would be deductible, the employee must generally complete an approved loan benefit declaration, showing the uses made of the loan and the deductible portion of the interest. A taxable benefit arises where an employer releases an employee (or associate) from a debt owed to the employer. The taxable value of the debt waiver fringe benefit is the value of the amount waived. Example 1 Assume that on 1 April 2020 John’s employer gives him a loan of $50,000 for five years at an interest rate of 4% pa. Interest is charged and paid six-monthly, and no principal is repaid until the end of the loan. The interest that is payable by the employee on the loan for the 2020/21 FBT year is $2,000 (ie $50,000 × 4%). The notional interest, using the 4.8% benchmark rate for 2020/21, is $2,400 (ie $50,000 × 4.8%). The taxable value of John’s loan fringe benefit is $400 ($2,400 − $2,000), ie

$50,000 × (4.8% − 4%) = $400

Example 2 Assume that Angela was provided with an interest-free loan of $8,000 from her employer on 1 April 2016, and no amount has been repaid since. The benchmark interest rate for the 2020/21 FBT year is 4.8% and the loan is used solely for private purposes. The taxable value of the loan fringe benefit for the 2020/21 FBT year is determined as:

$8,000 × (4.8% − 0%) = $384

Where an interest-free loan is made to an employee of a private company (who is also a shareholder), and only part of the loan is deemed to be a dividend under ITAA36 Div 7A, the remaining part of the loan is not a fringe benefit. That is because the definition of “fringe benefit” does not include anything done in relation to a shareholder (or associate of a shareholder) in a private company that causes a dividend to be taken to be paid to the shareholder or associate. If an employer mistakenly pays an amount to an employee that the employee is not legally entitled to, but is obliged to repay, and the employer subsequently allows the employee time to repay the amount, a loan fringe benefit will arise (TD 2008/10). A loan benefit can arise and continue even where the obligation to repay an amount or part of it is not enforceable by legal proceedings. It is the employer’s allowing of time to the employee to repay the mistakenly paid amount (rather than the employer’s payment under a mistake) that gives rise to a loan benefit. Accordingly, the loan benefit will not be excluded from being a loan fringe benefit as it is not a payment of salary or wages. However, in some circumstances, the loan fringe benefit may be excluded as an exempt benefit (eg a minor benefit under FBTAA s 58P). Exemptions

Certain exemptions may apply to employee advances in respect of bonds or security deposits and loans by employers who carry on a business of making loans to the public (see “Exempt loans” in ¶3-200).

¶3-445 In-house benefits An in-house fringe benefit can be an in-house expense payment fringe benefit (s 22A), an in-house property benefit (s 42) or an in-house residual fringe benefit (s 48, 49) (FBTAA s 136(1)). An in-house property fringe benefit, in relation to an employer, means a property fringe benefit in relation to the employer in respect of tangible property (¶3-200) (ID 2010/135: gift card not a property fringe benefit). An in-house property fringe benefit does not arise when a retail store employer provides an employee with a voucher/coupon entitling the employee to merchandise from a participating retail store of the employer; it arises when the employee redeems the voucher/coupon (ID 2014/17). In-house fringe benefits arise when employees receive goods or services from their employer or an associate of their employer that are identical or similar to those provided to customers by the employer or an associate of the employer in the ordinary course of business. The taxable value of in-house fringe benefits is 75% of either the lowest price at which an identical benefit is sold to the public or under an arm’s length transaction. In addition, depending on the nature of the inhouse fringe benefit, the aggregate taxable value may be reduced by a further $1,000 (¶3-700) Valuation — property produced for sale If the property is provided by an employer or associate who manufactures, produces, processes or treats the type of property concerned, the valuation rules are as follows: • If the goods are identical to goods normally sold by the employer to manufacturers, wholesalers or retailers, the taxable value of the benefit is the amount by which the employer’s lowest arm’s length selling price exceeds the amount, if any, paid by the employee. • If the goods are identical to goods normally sold by the employer to the public by retail, the taxable value of the benefit is the amount by which 75% of the lowest price charged to the public exceeds the amount, if any, paid by the employee. • Where the goods are similar, but not identical, to those sold by the employer (eg “seconds”), the taxable value of the benefit is 75% of the amount which the employee could be expected to pay for the goods at arm’s length, less the amount, if any, paid by the employee (FBTAA s 42(1)(a)). The taxable value of a “house and land package” provided by a property developer employer to an employee is not calculated as an in-house property fringe benefit in accordance with s 42(1) (ID 2004/211; Investa Properties Ltd v FC of T 2009 ATC ¶10-080). Valuation — property purchased for resale Where the property was acquired by the provider, and is of a sort that the provider would normally sell in the course of business, the taxable value of the benefit is the arm’s length price paid by that person less the amount, if any, paid by the employee (s 42(1)(b)). Valuation — in-house residual fringe benefit The taxable value of an in-house residual fringe benefit is generally 75% of the lowest price charged to the public for the same type of benefit, less any amount actually paid for the benefit (s 48, 49). There is a general exemption for the first $1,000 of the taxable value for each recipient employee each year for certain in-house benefits, including in-house property benefits valued under any of the above rules (¶3700). If the benefit is similar, but not identical, to benefits provided to the public, the taxable value is 75% of the amount that would reasonably be paid at arm’s length for the benefit, less any amount actually paid by the employee (ID 2004/487, ID 2008/30, ID 2012/85 and ID 2012/86). In determining the taxable value of an in-house residual expense payment fringe benefit (under FBTAA s 22A(2)), the lowest price at which an identical benefit is sold to a member of the public (in terms of

FBTAA s 48) does not reflect any reduction in premium or rebate provided by the Commonwealth Government to an employee under the Private Health Insurance Incentives Act 2007. The reduction in premium or rebate will constitute a recipient’s contribution (see ¶3-550) (ID 2012/85; ID 2012/86). Airline transport fringe benefits The rules for calculating the taxable value of airline transport fringe benefits are aligned with the general provisions dealing with in-house property fringe benefits and in-house residual fringe benefits, as below: • the taxable value of an airline transport fringe benefit is calculated as 75% of the stand-by airline travel value of the benefit, less the employee contribution • where the transport is on a domestic route, the stand-by airline travel value is 50% of the carrier’s lowest standard single economy airfare for that route as publicly advertised during the year of tax, and • where the transport is on an international route, the stand-by airline travel value is 50% of the lowest of any carrier’s standard single economy airfare for that route as publicly advertised during the year of tax. In-house fringe benefits under salary sacrifice arrangements The in-house fringe benefits concessions were originally included in the FBT law to reflect, among other things, the true cost of the benefits to employers, with the concessions applying by way of special valuation rules as noted above, specific exemption provisions, and reductions of aggregate taxable value (¶3-700). The concessions were not intended to allow employees to access goods and services by agreeing to reduce their salary and wages (through salary packaging arrangements) in order to buy goods and services using pre-tax income. To provide equity in cases where employees access concessionally taxed fringe benefits through salary sacrifice arrangements (and thereby receive tax-free non-cash remuneration benefits for goods and services while other employees or self-employed persons acquiring these items are required to pay for them out of after-tax income), the special rules below apply to benefits which are provided under salary packaging arrangements: • the concessional valuation for in-house expense payment benefits, in-house property benefits and inhouse residual benefits do not apply (FBTAA s 42(1), 48, 49). Instead, the taxable value of the inhouse fringe benefit is an amount equal to its “notional value” (depending on the nature of the benefit, this is either the lowest price that an identical benefit is sold to the public, or the lowest price under an arm’s length transaction) • the specific exemption for residual benefits with respect to private home to work travel using public transport (where the employer and associate are in the business of providing transport to the public) does not apply (FBTAA s 42) • the annual reduction of aggregate taxable value of $1,000 does not apply to in-house benefits (see ¶3-700).

¶3-450 Living-away-from-home allowance fringe benefit A living-away-from-home allowance (LAFHA) fringe benefit arises where an allowance or benefit is provided to an employee who is required to live away from their usual place of residence (or normal residence) in order to perform employment duties. The period that such an employee is required to live away from home is referred to the LAFHA period (see below). Unlike most other types of fringe benefits, a LAFHA fringe benefit can only be provided by the employer to the employee. Instead of paying a LAFHA, an employer may choose to pay for an employee’s accommodation by way of an expense payment benefit or residual benefit. Similarly, the reasonable food component may be paid by way of an expense payment benefit or property benefit. LAFHA periods

LAFHA benefits arise where an employee’s duties of employment require them to live away from their normal residence (or usual place of residence for offshore oil and gas rig workers). The employee must: • either: – maintain an Australian home, with the LAFHA relating to the first 12 months an employee lives away from home, or – work on a fly-in fly-out (FIFO) or drive-in drive-out (DIDO) basis • complete a declaration confirming either of the above. A payment provided to an offshore oil and gas rig worker may still be a LAFHA benefit even if the above requirements are not satisfied (s 30(2)). Accommodation expenditure incurred must be substantiated, while food and drink expenses need only be substantiated where they exceed the amount the Commissioner considers reasonable (see below). An employee substantiates these expenses by providing a declaration or receipts to their employer. The Commissioner determines for each FBT year the reasonable amounts under FBTAA s 31G for food and drink expenses incurred by employees receiving a LAFHA fringe benefit (see TD 2020/4 for the reasonable amounts for each adult, plus family members, per week within Australia and overseas for the 2020/21 FBT year). An employer can reduce the taxable value of the fringe benefit by the exempt food component if the expenses are either equal to or less than the reasonable amount or are substantiated in accordance with s 31G(2). No expenses substantiation is required where the total of food and drink expenses for an employee (including eligible family members) does not exceed the Commissioner’s reasonable amounts. Key concepts Employment duties requirement The employment duties must be the reason for the change of normal residence rather than the employer requiring the employee to live away from home (see the Compass Group case). Employee expenses are non-deductible A LAFHA must be paid for the additional expenses, or additional expenses and compensation for other disadvantages, of living away from home. The additional expenses do not include expenses for which the employee would be entitled to an income tax deduction (Roads and Traffic Authority of NSW v FC of T 93 ATC 4508; Taxation Determination TD 93/230). Also, an allowance to compensate only for “other additional disadvantages” without some clear connection with likely additional expenses will not be a LAFHA fringe benefit (Atwood Oceanics Australia Pty Ltd v Federal Commissioner of Taxation 89 ATC 4808; Taxation Determination TD 94/14). Calculating the taxable value of a LAFHA fringe benefit Employee circumstances . . .

The taxable value is . . .

Employee: • maintains a home in Australia at which they usually reside and it is available for their use at all times • receives a LAFHA fringe benefit which relates to the first 12-month period at a particular work location, and • gives the appropriate declaration about living away from home

the amount of the LAFHA paid, less • any exempt accommodation component, and • any exempt food component

Employee:

the amount of the LAFHA paid, less

• works on a FIFO or DIDO basis • has residential accommodation at or near their usual place of employment, and • gives the employer the appropriate declaration about living away from home

• any exempt accommodation component, and • any exempt food component

Employee: • does not fall into either of the above situations

the amount of the fringe benefit.

The taxable value is not reduced by any exempt food component to the extent the fringe benefit relates to a period during which the employee resumes living at their normal residence. This means that if an employer pays an allowance for food or drink during any days that the employee returns home, the allowance relating to those days is fully taxable for FBT purposes. Employees are required to provide declarations and to substantiate expenses. The “otherwise deductible” rule (¶3-500) does not apply to LAFHA benefits. Rather than paying a cash LAFHA while an employee is required to live away from home, an employer may provide accommodation and/or food for the employee or, alternatively, reimburse the employee for these expenses. In these instances, the benefits must be valued by reference to the valuation rule for the particular type of benefit and the following reduction and exemption may apply in these circumstances: • living-away-from-home — food provided (reduction is fringe benefit taxable value) • living-away-from-home — accommodation (tax-exempt benefit).

¶3-500 The “otherwise deductible” rule The taxable value of a fringe benefit provided to an employee can be reduced under the “otherwise deductible” rule (FBTAA s 19(1): loan fringe benefit, s 24(1): expense payment benefit, s 44(1): property benefit, s 52(1): residual benefit). Where an employee receives a benefit, and would have been entitled to an income tax deduction for expenditure which were incurred personally on the benefit, the employer can reduce the taxable value of the benefit by the amount of that notional deduction that the employee would otherwise have been able to claim. The reduction is available regardless of whether the employer would have been entitled to a deduction for the expenditure. The otherwise deductible rule does not apply to reduce the employer’s FBT liability if the fringe benefit is instead provided to the employee’s associates (eg a spouse). That is, the taxable value of such benefits cannot be reduced by the otherwise deductible rule. Calculation of reduction amount under otherwise deductible rule A four-step approach is used by an employer to determine the reduction amount in the taxable value of a fringe benefit provided to an employee: (1) determine the employee’s expense amount before reimbursement (2) work out the amount of the expense that the employee could normally claim as an income tax deduction (3) determine how much the employee can actually claim as a tax deduction if: (a) the employer reimburses the employee all or part of the business component of the expenses (the employee’s tax deduction is the expenses amount multiplied by the business percentage, and reduced by the reimbursement amount) (b) the business component of the expense is not taken into account (the employee’s tax deduction is the expenses amount reduced by the reimbursement amount, and multiplied by the business percentage)

(4) subtract the actual deductible amount (Step 3) from the hypothetical deductible amount (Step 2). The result is the amount by which the employer can reduce the taxable value of the fringe benefit. Step 2 is different where the costs of operating the employee’s own car are involved. In that case, three methods are available (the logbook record, logbook and odometer records and percentage of business use methods), with different substantiation requirements and varying results. Employers must obtain the relevant declaration and documentary evidence from employees concerned before the due date for lodgment of the FBT return for each year. The declaration must generally show the nature of the expenditure to establish its relationship to the production of assessable income and the extent to which it would have been deductible to the employee. (see also “Taxable value of a fringe benefit provided jointly to an employee and associate” below). Otherwise deductible rule and property fringe benefit The test of the otherwise deductible rule in s 52 (property benefit) requires a conclusion to be reached about whether the hypothetical expenditure of money would have been allowable as a deduction if the employee had incurred that expenditure. This hypothesis requires making the assumption that the expenditure actually incurred by the employer had been incurred by the employee; it does not require, or permit, the consideration of alternative facts or circumstances. The section does not permit, or require, the Commissioner to hypothesise about other reasonably likely alternative losses or outgoings but, rather, calls for a judgment about whether the expenditure actually incurred would have entitled the employee to obtain a deduction upon the hypothesis that it had been incurred by the employee rather than the employer (John Holland Group Pty Ltd & Anor v FC of T 2015 ATC ¶20-510, [2015] FCAFC 82: ¶3-200). Otherwise deductible rule and expense payment fringe benefit An expense payment fringe benefit may arise in either of two ways — the employer reimburses an employee for expenses incurred or the employer pays a third party to satisfy expenses incurred by the employee. The expenses may be business or private expenses, or a combination of both. The taxable value of the expense payment fringe benefit is the amount of payment or reimbursement made by the employer (¶3-430). Under the otherwise deductible rule, the taxable value may be reduced by the amount which the employee would have been entitled to claim as an income tax deduction had the employee not been reimbursed by the employer. Thus, if an employee incurred an expense solely in the performance of employment-related duties, the expenditure would be wholly tax deductible. Under the otherwise deductible rule, if the employer reimbursed the employee for all or part of this expense, the taxable value of the expense payment fringe benefit would be nil. The otherwise deductible rule will therefore produce different results depending on whether the employer’s reimbursement was for the business element of the expense payment fringe benefit. This is because the employee is only entitled to a tax deduction to the extent of the expenditure incurred to derive assessable income of the employee, and no deduction is allowed for the portion of the expenditure incurred in relation to a private or domestic purpose. The following example, in relation to an expense payment fringe benefit, can similarly be applied to the other fringe benefits (see above) to which the otherwise deductible rule applies. Example Assume: (1) Betty, an employee, incurred expenditure of $500, of which 80% was employment-related (and tax deductible) and 20% was private (2) Betty was reimbursed $250 by her employer without regard to whether the expenditure was for business or private purposes (3) without the otherwise deductible rule, the taxable value of the expense payment fringe benefit is $250. Applying the otherwise deductible rule Step 1: Amount of Betty’s gross expenditure (before any employer reimbursement) — $500. Step 2: If Betty is not reimbursed for any of the expenditure in Step 1, what would have been tax deductible for her? (This represents a hypothetical deductible amount.) — $500 × 80% = $400.

Step 3: On the facts (ie with the employer reimbursement), what amount of the expenditure can Betty claim as a tax deduction? The tax-deductible amount is calculated as the amount of Betty’s expenditure (reduced by the reimbursement amount) multiplied by the business percentage — ($500 − $250) × 80% = $200. Step 4: Subtract the actual deductible amount in Step 3 from the hypothetical deductible amount in Step 2 to determine the reduction amount in the taxable value of the fringe benefit — $400 − $200 = $200. The $250 taxable value of the expense payment fringe benefit is reduced by $200 to $50.

Example Assume the same facts in the previous example except that: • the employer made a reimbursement of $350 after considering the extent to which Betty’s expenditure was employment-related and tax deductible. That is, Betty’s employer knew that under the otherwise deductible rule there would be no FBT liability for that part of the fringe benefit that was applied to an income-generating purpose and so avoided reimbursing the private or domestic part of Betty’s expenditure • the taxable value of the expense payment fringe benefit (without the otherwise deductible rule) is $350. Applying the otherwise deductible rule Steps 1 and 2 are the same as in the first Example (above). Step 3: On the basis of the actual fringe benefit (ie with the employer reimbursement), what amount of the expenditure can Betty claim as a tax deduction? The tax-deductible amount is calculated as the amount of Betty’s expenditure (multiplied by the business percentage) reduced by the amount of the reimbursement — ($500 × 80%) − $350 = $400 − $350 = $50. Step 4: Subtract the deductible amount in Step 3 from the hypothetical deductible amount in Step 2 to determine the reduction amount in the taxable value of the fringe benefit — $400 − $50 = $350. The $350 taxable value of the expense payment fringe benefit is reduced by $350 to nil.

In certain cases, the employer can further reduce the taxable value of an expense payment fringe benefit that has been reduced by the otherwise deductible rule, eg with benefits such as remote area housing assistance, relocation travel or employee interviews/selection test travel by employee’s car. Taxable value of a fringe benefit provided jointly to an employee and associate Where a fringe benefit is provided jointly to an employee and the employee’s associate, the employer’s FBT liability on the taxable value of the fringe benefit will only be reduced to the extent the employee’s share of the fringe benefit is used for income-producing purposes. To prevent the double-counting under the FBT regime, a fringe benefit provided jointly to an employee and one or more associates of the employee is deemed to be provided solely to the employee (FBTAA s 138(3)). The employer in National Australia Bank Ltd v FC of T 93 ATC 4914 provided low-interest loans jointly to the employee husband and his wife which were invested in a jointly held investment property (a loan fringe benefit). The Federal Court held that, as a result of s 138(3), the employee was the sole recipient of the loan fringe benefit. It further held that as sole recipient of the loan and sole investor of the proceeds, if the employee husband had incurred and paid unreimbursed interest on the loan, he would have been entitled to a deduction for the expense. Thus, under the otherwise deductible rule, the taxable value of the loan fringe benefit was reduced to nil so that the employer had no FBT liability arising from the loan fringe benefit provided to both the employee and his spouse. This is inconsistent with the general income tax position that income and deductions arising from jointly owned rental property should be allocated between joint owners in accordance with their interest in the property (eg joint tenants in a rental property would include 50% of the rental income in their assessable income and claim 50% of the rental property expenses). The anomaly in the NAB case had previously led to arrangements involving expense payment fringe benefits where spouses on a higher marginal tax rate could salary sacrifice their income by an amount equivalent to the joint rental expenses, thus allowing the spouse on the higher marginal tax rate through a salary reduction to effectively claim a deduction for the entirety of the rental expenses despite owning only a share in a jointly held investment. To remedy that anomaly, an adjustment to the taxable value must now be made when applying the otherwise deductible rule where a fringe benefit is provided jointly to an employee and the employee’s

associate but is deemed to be provided solely to the employee because of s 138(3). The adjustment reduces the unadjusted notional deduction by the employee’s percentage of interest in the incomeproducing asset or thing (whether tangible or intangible) to which the benefit relates, thus ensuring that the taxable value of the benefit is only reduced by the employee’s share of the benefit. Example Nellie and her husband (Jack) are jointly provided with a $100,000 low-interest loan by Nellie’s employer which they use to acquire shares. The loan fringe benefit has a taxable value of $10,000. Nellie and Jack use the loan to purchase $100,000 of shares which they will hold jointly with a 50% interest each. Nellie and Jack return 50% of the dividends derived from the shares as assessable income in each of their income tax returns. When applying the otherwise deductible rule, the notional deduction of $10,000 is reduced by Nellie’s 50% interest in the shares so that the taxable value of the loan fringe benefit of $10,000 is reduced by $5,000. The employer has an FBT liability on $5,000 which reflects the share of the loan fringe benefit that was provided to Jack.

The adjustment to the notional deduction will also apply to reduce the taxable value of a loan, expense payment, property or residual fringe benefit in circumstances where the fringe benefit is applied only partly for income-producing purposes, where more than one income-producing asset is held or where there is a change, in the FBT year, of the employee’s percentage of interest in the income-producing asset. Example Assume the facts in the above example, except that Nellie and Jack only use 50% of the $100,000 loan for acquiring shares and use the other 50% ($50,000) for a private overseas holiday. The taxable value of the loan fringe benefit that relates to that part of the loan used for private purposes ($5,000) is not deductible to either Nellie or Jack so the otherwise deductible rule does not apply to reduce that part of the loan fringe benefit. The taxable value of the loan fringe benefit that arises on that part of the loan that is used for acquiring shares can be reduced by Nellie’s share of the benefit (ie $2,500). The employer can reduce the taxable value of the loan fringe benefit ($10,000) by $2,500. The taxable value of the loan fringe benefit provided to Nellie and Jack that will be subject to FBT is $7,500 ($10,000 − $2,500).

Deferral of losses from non-commercial business activities Taxation Ruling TR 2013/6 sets out guidelines on whether a “once-only deduction” arises in calculating the taxable value of an external expense payment fringe benefit under FBTAA s 24 where the expenditure associated with that fringe benefit would be subject to the loss deferral rule in s 35-10(2) of ITAA97 Div 35 (about the deferral of losses from non-commercial business activities). The ruling also generally applies to other FBTAA provisions expressing the same ideas as s 24. Specifically, the ruling considers: • whether the terms “deduction” and “allowable” in both the definition of “once-only deduction” in FBTAA s 136(1) and in s 24 refer to a deduction allowable under a specific provision or to a deduction taken into account in calculating taxable income under s 4-15 of the ITAA97, and • whether expenditure, which, had it been incurred by the recipient of an external expense payment fringe benefit and not reimbursed and would have been affected by the loss deferral rule in s 3510(2), can ever give rise to a once-only deduction. Taxation Determination TD 2013/20 states that when an employer reimburses an amount of expenditure incurred by an employee to a third party, under a salary sacrifice (or similar) arrangement with that employee where that expenditure is notionally subject to ITAA97 Div 35, the amount included under ITAA97 s 35-10(2E) is increased when applying the “otherwise deductible rule” in s 24. Other ATO guidelines on deductibility of particular types of expenses Taxation Ruling TR 2020/1 contains guidelines on employee deductions for work expenses under ITAA97 s 8-1, and Appendix 1 to the Ruling provides a list of work expense categories and issues with links to relevant ATO rulings, determinations and other materials.

The Ruling provides both foundation guidance on general deductibility principles and direction to the more specific guidance products that are of most relevance to particular issues or expense types. Examples of these are Draft Taxation Ruling TR 2017/D6: when are deductions allowed for employees’ travel expenses; Draft Taxation Ruling TR 2019/D7: deductibility of transport expenses, which partially replaces TR 2017/D6; Miscellaneous Taxation Ruling MT 2027: private use of cars for home to work travel; IT 2614: employee expenses incurred on relocation of employment; Taxation Ruling TR 97/12: deductibility of expenses on clothing, uniform and footwear; Taxation Ruling TR 2012/8: assessability of amounts received to reimburse legal costs incurred in disputes concerning termination of employment; and Taxation Ruling TR 2000/5: costs incurred in preparing and administering employment agreements. The ATO states that a further draft ruling on the deductibility of meals and accommodation will be published during 2020. Pending that additional guidance, the ATO will continue to accept that where an employee is away from home overnight for work for 21 days or less, the employee will be treated as travelling for work purposes rather than living away from home, and the allowance paid by the employer will be treated as a travel allowance (www.ato.gov.au/General/ATO-advice-and-guidance/Advice-underdevelopment-program/Advice-under-development---income-taxissues/#BK_3756Deductionforworkrelatedtravelexpe).

¶3-550 Employee contribution towards a benefit A fundamental concept of FBT is that, if an employee makes a contribution towards the provision of a benefit, the taxable value of the benefit is reduced by the amount of the contribution. This ensures that the employer is only taxed on the value of the net benefit provided to the employee. An “employee contribution” is variously referred to in the FBTAA as the “recipients contribution” (airline transport, property, residual, board and expense payment fringe benefits), the “recipients payment” (car fringe benefits) and the “recipients rent” (housing fringe benefits). While there are technical differences, each expression is defined to mean, broadly, the amount of the employee consideration (contribution) in respect of the employer providing the fringe benefit. Essentially, there needs to be a sufficient or material connection between the employee contribution or payment and the provision of the particular fringe benefit to the employee. There is no requirement that the consideration be paid by any particular time. However, except in the case of expense payment benefits, the definitions expressly require that the payment by the employee must be by way of consideration for the benefit (an implied requirement in the case of expense payment benefits). That is, the employee must be required to make the payment in return for obtaining the benefit. For example, this test is met if, at the time the benefit is provided, it was intended that the employee would make a future payment for the benefit equal to the benefit’s taxable value before deducting the employee contribution. On the other hand, the test will not be met if the benefit as originally provided was purely by way of remuneration without any intention that the employee subsequently makes a payment for the benefit. An employee will usually contribute towards the cost of the fringe benefit by way of a cash payment to the employer or the person providing the benefit. In the case of a car fringe benefit, the contribution can also be made by paying for some of the operating costs, such as fuel, if these are not reimbursed by the employer. If an employee is provided with an expense payment fringe benefit in relation to the payment of a proportion of the interest incurred on a loan granted to the employee by the employer, the employee’s payment of the remaining interest is not a recipient’s contribution (ID 2012/88). The payment of the remaining interest is made in respect of the employee’s obligation under the loan agreement and not the provision of the expense payment fringe benefit, ie there is not a sufficient or material connection between the employee’s payment of the remaining interest and the provision of the expense payment fringe benefit. For examples of a recipient’s contributions to in-house residual expense payment fringe benefits where a rebate or reduction in premium is given to an employee, see ID 2012/85 and ID 2012/86. An employee contribution must be made from the employee’s after-tax salary. A “salary sacrifice” (¶3850) of an amount of salary or a contribution of services as an employee does not constitute an employee contribution.

An employee contribution may mean that a GST liability arises for the employer, with the GST attributable to the period in which the contribution was received. Any GST payable will be 1/11th of the employee’s contribution. No GST is payable on the supply of fringe benefits (including exempt benefits) that are not taxable supplies. Examples are where the benefit was either GST-free or input taxed, or where the provider was not registered, or required to be registered, for GST (¶3-950).

FBT EXEMPTIONS AND CONCESSIONS ¶3-600 Exemptions from FBT There are several reasons why a benefit provided to an employee may not attract FBT. The payment or benefit may be exempted from FBT (see “Exempt benefits” below) or may not be a “fringe benefit” under the FBTAA (see “Certain payments or benefits are not fringe benefits” below), or an exemption is available for particular types of employers (see below and ¶3-650). Exempt benefits In addition to the exemptions applying to particular classes of fringe benefits (eg car parking: ¶3-420, expense payment: ¶3-430), some benefits (referred to as “exempt benefits” in the FBTAA, and sometimes inappropriately called “exempt fringe benefits” by some commentators) are specifically exempted from FBT. The term “exempt benefit” is not defined, and the FBTAA specifically provides for these benefits to be exempt from FBT (eg see FBTAA s 53 to 58ZD: “Miscellaneous exempt benefits”). These benefits are not only exempt from FBT but are also exempt from income tax in the hands of the employee (for an exception, see “Car expenses — expense payments”). International organisations, diplomatic and consular immunities Benefits provided by the following employers are exempt benefits: • certain international organisations that are exempt from income tax and other taxes by virtue of the International Organisations (Privileges and Immunities) Act 1963 • organisations established under international agreements to which Australia is a party and which oblige Australia to grant the organisation a general tax exemption. A benefit that would be exempt from tax in Australia by the operation of the Consular Privileges and Immunities Act 1972 or the Diplomatic Privileges and Immunities Act 1967 is an exempt benefit. Miscellaneous exempt benefits Some common exempt benefits are: • provision of certain work-related items (s 58X) — see below • employment interview — benefits relating to travel (eg meals, accommodation) for current and future employees to attend job interviews/selection tests (s 58A) • relocation expenses for employment reasons — expenses for travel, removal of furniture, temporary accommodation, cost of leasing furniture for temporary accommodation, relocation consultant, connection of telephone, electricity or gas services, meals and home sale and purchase costs, such as stamp duty and agent’s commission (ID 2013/8: the change of usual place of residence is not required to be compulsory; rather, the change may be one that is necessary in the circumstances for the employee to perform the duties of their employment; ID 2013/35: cost of visa application for a non-resident employee to remain in Australia not an exempt benefit as the employee was already in Australia) (s 58AA–58F, 61B, 143A) • membership fees and subscriptions — an employee’s subscription to trade/professional journal, corporate credit card membership, airport lounge membership (s 58Y)

• newspapers and periodicals — provided to employees for business use (s 58H) • taxi travel — taxi travel provided by employers to employees for travel beginning or ending at the employee’s place of work, or for sick employees for travel home or to any other place to which it is necessary or appropriate for the employee to go as a result of illness or injury (eg to a doctor or a relative) (s 58Z) (see “Taxi travel exemption” below) • compassionate travel/emergency help — travel (including necessary accommodation and meals) for employees at times of death/serious illness in the family, and basic shelter, food and clothing at a time of an emergency (s 58LA, 58N) • awards for long service (subject to a limit of $1,000 for 15 years’ service, plus $100 for each additional year’s service), safety awards (s 58Q, 58R) • workers compensation (whether required under an industrial instrument or not), work site medical facilities, and occupational health and counselling (s 58J) • remote area housing benefits (¶3-700) • minor benefits of less than $300 — small value benefits provided infrequently and/or are difficult to value (s 58P) • worker entitlement funds — payments to funds set up to protect employee entitlements on insolvency or to provide for redundancy/long service leave entitlements, as required by an industrial law/award (s 58PA, 58PB) (ID 2012/95: contribution to a fund to provide income protection insurance to its employees is not exempt benefit). Such funds must comply with the operating conditions prescribed in FBTAA. If an employer reimburses an employee for fees incurred to park the employee’s car at the local airport while the employee is working interstate at a remote location, the reimbursement constitutes an exempt benefit under FBTAA s 58G(1)(a) (ID 2012/18). Eligible work-related items The FBT exemption for “eligible work-related items” (FBTAA s 58X) is designed to reduce the cost of compliance by removing the need for employers to obtain declarations stating the percentage of employment-related use in applying the “otherwise deductible” rule (generally, the extent to which the employer could obtain a deduction in relation to the benefit, as the benefit would have been deductible to the employee: ¶3-500). Each of the following is an eligible work-related item if it is primarily for use in the employee’s employment (see ID 2008/127: factors to determine the “primary” use requirement). The s 58X exemption is limited to one item of each type that has substantially identical functions per FBT year, unless the item is a replacement of another item acquired earlier in the FBT year: • a portable electronic device, eg a mobile phone, calculator, personal digital assistant, laptop, portable printer, and portable global positioning system (GPS) navigation receiver (rather than a specific item, such as a laptop computer: see ID 2008/158 below) • an item of computer software • an item of protective clothing • a briefcase, and • a tool of trade. A combination of a tablet PC and a laptop computer or a phablet and a tablet PC will be eligible for the exemption but not a combination of a smartphone and a phablet or a tablet PC hybrid and a laptop computer because they are considered to have “substantially identical functions” and an exemption is not

available for the second item provided to an employee in the same FBT year unless s 58X(3) or (4) applied (NTLG FBT Sub-committee meeting, 16 May 2013). Modifications to the application of s 58X apply to a small business entity from 2016/17, see “FBT exemption for multiple portable electronic devices — small businesses” below. In addition, employees are denied decline in value deductions for eligible work-related items that are depreciating assets, the asset is provided as an expense payment fringe benefit (¶3-430) or a property fringe benefit (¶3-200) and the benefit is exempt under s 58X. In ID 2008/158, an employee purchased a laptop computer and, at the time of purchase, also requested additional memory be included in the computer. The laptop computer and the additional memory were itemised on one invoice. The employer agreed to reimburse the employee for the cost of the laptop and additional memory (ie the total invoiced amount). The employer’s reimbursement is an expense payment benefit (FBTAA s 20(b): ¶3-430). The ATO stated that s 58X(2)(a) applies to any computer upgrades made at the time of purchase involving built-in internal components, such as additional memory, bigger hard drive, internal modem or wireless LAN module, which are ordered and itemised on the one invoice (even at a separate cost). These items are clearly not peripheral items, but form part of the laptop computer. It is no different, in effect, from simply purchasing a laptop computer model with better specifications at an increased cost. However, where the employee requests peripheral items such as cables, modems or cradles or an extension to the warranty that is offered, these come at an additional cost and are not covered by the exemption. If an employer reimburses an employee over a period spanning two FBT years for the cost the employee incurred to purchase a laptop computer, the employer cannot provide another laptop computer to the employee in the second FBT year as an exempt benefit. Where there has been either an expense payment or property benefit in relation to a laptop computer earlier in an FBT year, the provision of another laptop computer in that same year will not be an “eligible work-related item” and therefore will not be an exempt benefit under s 58X(1) (ID 2008/159). If an employer pays an employee’s loan repayments, where the loan was taken out by the employee to purchase an eligible work-related item, the repayment of the employee’s loan is not considered to be referable to the purchase of an eligible work-related item and is therefore not an exempt benefit under s 58X(1)(a) (ID 2008/160). FBT exemption for multiple portable electronic devices — small businesses The FBT exemption in s 58X applies to eligible work-related items (see above) provided by way of an expense payment benefit, a property benefit or as a residual benefit (as defined in FBTAA s 136(1)), subject to the limitations on the exemption (ie the item is primarily for use in an employee’s employment (s 58X(2): work-related use)); one item per FBT year for items that have a substantially identical function, unless the item is a replacement (s 58X(3), (4)). For the 2016/17 and later FBT years, the substantially identical functions limitation does not apply to a “small business entity” (¶2-335) employer that provide multiples portable electronic devices to an employee in an FBT year. This means that a small business can provide a portable electronic device to an employee that has substantially identical functions to a device already provided to that employee in the same FBT year, and all of the devices will be exempt from FBT (s 58X(4)(b)). The requirement that devices are primarily for use in the employee’s employment (the work-related use test) remains unchanged. The substantially identical functions test in s 58X(3) will still apply with respect to the other eligible work-related items (see above). Taxi travel exemption In pre-2019/20 FBT years, a “taxi” was defined in the FBTAA as “a motor vehicle licensed to operate as a taxi”. As a result of ride sharing providers (see below) entering into a market that has been the subject of considerable regulatory reform, this has become difficult to administer as the meaning of “licensed to operate as a taxi” is highly contentious and may differ considerably between the States and Territories depending on their licensing laws. To avoid these difficulties and remove unintended restrictions on market innovation and competition, the term “taxi” is defined for FBT years starting on 1 April 2019 as “a motor vehicle used for taxi travel (other

than a limousine)”. The term “limousine” is not defined and has its ordinary meaning (Uber B.V. v FC of T [2017] FCA 110; 247 FCR 46, Dreamtech International Pty Ltd v FC of T [2010] FCA 109; 187 FCR 352). In summary, in addition to licenced taxi travel, the exemption from 1 April 2019 applies to travel that an employer provides to employees in vehicles involving the transport of passengers for a fare (other than in a limousine), such as ride-sourcing travel. Ride sourcing travel generally means a travel arrangement made via a third-party digital platform (such as a website or an app) to request a ride, for example, through Uber, Hi Oscar, Shebah, or GoCatch. Also, the exemption applies to any benefit arising from taxi travel by an employee if the travel is a result of sickness of, or injury to, the employee, and the whole or a part of the journey is directly between the employee’s place of work or residence, or any other place that it is necessary, or appropriate, for the employee to go as a result of the sickness or injury. Car expenses — expense payments An exempt benefit may arise where an employer reimburses the operating expenses of an employee’s own car (eg reimbursement on an agreed number of cents per kilometre travelled in the car), with some exceptions. This is the only exempt benefit that constitutes assessable income in the hands of the employee, as other exempt benefits are both exempt from income tax and exempt from FBT. The exempt benefit does not arise where the car expenses reimbursement relates to: • holiday transport from a remote area • overseas employment holiday transport • relocation transport • transport to an employment interview or selection test • transport to a work-related medical examination, work-related medical screening, work-related preventative health care, work-related counselling or migrant language training, or • transport was provided after the employee had ceased to perform the duties of that employment. Car expenses exempt benefit does not include road and bridge (R&B) tolls, and employers will need to obtain a declaration from employees or prepare a no-private-use declaration to reduce or exempt tolls from FBT. R&B tolls are not a separate category of fringe benefits but are either an expense payment benefit (where the employer pays or reimburses the employee expenditure) or a residual benefit (where the employee uses the employer’s electronic toll tag: ¶3-200). Certain payments or benefits are not fringe benefits A “benefit” is defined widely for FBT purposes to include any right, privilege, service or facility (¶3-200). However, many payments and benefits in respect of employment are expressly stated not to be fringe benefits (as specified in para (f) to (s) of the definition of “fringe benefit” in FBTAA s 136(1)). The main exclusions (ie non-fringe benefits) are: • salary or wages (para (f)) • an exempt benefit (para (g)) • benefits under employee share schemes or trusts, including in respect of individuals engaged in foreign service, certain stapled securities acquired under such schemes and indeterminate rights (para (h)–(hd); ID 2010/108, ID 2010/142: ESS indeterminate rights not fringe benefits) • most employer superannuation contributions (para (j), see below) • superannuation benefits and lump sum payments on termination of employment (para (k), (l)–(le)) • capital payments for enforceable restraint of trade contracts or personal injury (para (m))

• payments deemed to be dividends for income tax purposes (para (n)) • a payment made, or liability incurred, to a person to the extent that the payment or liability is nonassessable non-exempt income (within the meaning in ITAA 1997) of the person because of ITAA97 s 26-35(4) (para (p)) (this ensures that FBT is not payable on non-deductible payments to relatives) • amounts that have been subject to family trust distribution tax (para (q)) • anything done in relation to a shareholder in a private company or an associate of a shareholder, that causes (or will cause) the private company to be taken under Div 7A of Pt III of the ITAA36 to pay the shareholder or associate a dividend (para (r), see below). Employee share schemes An employee share trust for an “employee share scheme” (ESS) is a trust whose sole activities are: (a) obtaining shares or rights in a company (b) ensuring that ESS interests in the company that are beneficial interests in those shares or rights are provided under the ESS to employees (or their associates) of the company or a subsidiary, and (c) other activities that are merely incidental to the activities mentioned in para (a) and (b) (ITAA97 s 130-85(4)). A disqualifying activity of an employee share trust is where the other activities are not “merely incidental” (such as the provision of financial assistance, including a loan to acquire the shares; ID 2010/108). A share provided by a company to an employee to satisfy the exercise of a right, being a right to acquire a share of the company granted under an ESS is not a fringe benefit as the shares issued in respect of the rights are not provided “in respect of” the employee’s employment (ID 2010/219). Example A company grants rights to its employees under an ESS for nil consideration which entitles the employees to acquire shares in the company. The rights are subject to vesting conditions. When these conditions are met, the employees can exercise their rights to acquire the shares at no cost at which time the company will allocate the shares to the employees. The rights acquired by the employees under ESS are assessed under Div 83A of the ITAA97. When rights granted under the ESS are exercised, and shares are allocated by the employer, the benefit that arises comes as a consequence of the employee exercising the rights previously obtained under the scheme, and not in respect of employment. Therefore, this does not give rise to a fringe benefit, as no benefit has been provided to the employee in respect of an employment relationship.

Deemed dividends An amount lent by a private company to a shareholder during a current year is taken to be a dividend under Div 7A if the loan is not fully repaid before the private company’s lodgment day for that income year, and Div 7A Subdiv D does not otherwise prevent the private company from being taken to have paid a dividend to the shareholder (ITAA36 s 109D(1)). The amount of the deemed dividend is the amount of the loan not repaid at the relevant time, subject to s 109Y of the ITAA36 which limits the total amount of dividends taken to have been paid by the private company to the company’s distributable surplus as at the end of its year of income. The exclusion in para (r) of s 136(1) will preclude a loan from being a loan fringe benefit where the loan is taken to be a dividend, but the amount is reduced to nil in accordance with s 109Y (ID 2011/33: private company’s distributable surplus was nil). Superannuation contributions for employees Employer superannuation contributions paid in cash and in non-cash assets (eg listed shares and property) to a complying superannuation fund for employees are not fringe benefits. The employer can

also claim a tax deduction for the contributions if the relevant conditions for deductibility are met. However, if an employer makes contributions to a complying superannuation fund for an associate of an employee (eg the spouse or a related person), the employer is liable to FBT for the value of the contributions. These contributions are also not deductible for tax purposes. Employer superannuation contributions, being non-fringe benefits, are also not reportable fringe benefits. Employer superannuation contributions to a non-complying superannuation fund (eg a foreign fund) are subject to FBT. The contributions are also not tax deductible (¶4-210). Some employers pay expenses on behalf of a superannuation fund and later make journal entries that reclassify the expense payment as superannuation contributions for employees. Although there is no payment of money directly to a fund, the ATO accepts that payments made directly to a creditor of the fund of this nature that are accepted as deductible contributions by the superannuation fund are treated as superannuation contributions and, therefore, are not fringe benefits. The ATO has warned about arrangements that use offshore trust structures (purported to be superannuation funds) in an attempt to shift funds into Australia in a concessionally taxed manner, or substantially defer the time at which such amounts are subject to tax in Australia. Such arrangements may give rise to various tax issues (and regulatory issues under the Superannuation Industry (Supervision) Act 1993), including whether the offshore trust funds may be superannuation funds and whether the contributions to the offshore trust funds may be excluded from being fringe benefits (Taxpayer Alert TA 2009/19). Diagram of typical arrangement

¶3-650 Exempt employers and rebatable employers FBT concessions are available to not-for-profit employers in the form of: • FBT exemption or FBT rebate • exemption for certain benefits provided by registered religious institutions and non-profit companies • concessions for meal entertainment, car parking and remote area benefits. The expression “not-for-profit employers” is used to cover: • rebatable employers • public benevolent institutions (PBIs) and health promotion charities (HPCs) • public hospitals, not-for-profit hospitals and public ambulance services • not-for-profit organisation operating partly as an eligible PBI.

A non-profit entity that is a charity must be registered with the Australian Charities and Not-for-profits Commission (ACNC) and endorsed by the ATO. The sub-types of each registered charity according to its charitable purposes for FBT purposes are: • registered HPCs (a charity whose principal activity is to promote the prevention or the control of diseases in human beings) • registered PBIs (a PBI charity) • registered religious institution (see below) charity. ATO endorsement as a registered charity is required to access the FBT rebate and the FBT exemption (for PBIs and HPCs). Summary — not-for-profit capping threshold and FBT rebate rate FBT year ending

PBIs, HPCs, rebatable employers

Public and notfor-profit hospitals and public ambulance services

Meal entertainment and entertainment facility leasing expense benefits (all not-for-profit employers eligible for a cap)

FBT rebate rate

31 March 2018, 2019, 2020 and 2021

$30,000

$17,000

$5,000

47%

FBT exemption — subject to capping Organisations that are exempt from FBT for benefits provided to their employees up to a prescribed annual cap per employee include the following (FBTAA s 57, 57A): • registered PBIs (other than hospitals) and registered HPCs endorsed by the ATO • public and non-profit hospitals and public ambulance services. The exemption applies where the total grossed-up value of certain benefits (which are benefits not otherwise exempt: see “Benefits excluded from capping thresholds” below) provided to each employee during the FBT year is equal to or less than the capping threshold. If the total grossed-up value of fringe benefits provided to an employee is more than that of capping threshold, FBT is payable by the organisation on the excess. Organisation

Capping threshold

Registered PBIs and HPCs

$30,000 per employee

Public and non-profit hospitals and public ambulance services

$17,000 per employee

The full capping threshold applies even if the employer did not employ the employee for the full FBT year. For example, if a registered PBI employed an employee between October and March and the total grossed-up value of benefits provided was $25,000, FBT will not be payable. Certain entertainment benefits under salary packing arrangements may be eligible for a separate exemption cap (see below). Hospital work — what duties are covered? The duties of the employment of an employee of a government body are exclusively performed in, or in

connection with, a public hospital or a non-profit hospital for the purposes of the term “exclusively” in FBTAA s 57A(2)(b) when the duties are performed: • “in” the hospital such that the employee performs their duties in the physical location of the hospital facility and within that facility at a place where activities are conducted that enable the hospital to carry out its functions, or • “in connection with” the hospital such that the employee is engaged in activities that enable the hospital to carry out its functions. These duties may be performed at places other than “in” the hospital. Where an employee engages in separate job positions during a year, each job position must be considered separately for the purpose of determining whether the criteria in s 57A(2) are satisfied. Where an employee has more than one job position during the year, it is possible for s 57A(2) to apply to the benefits provided in respect of one of the positions even if the requirements of s 57A(2) are not met in relation to the other position. Also, that requirement will be met if an employee performs some of their duties “in” a hospital and undertakes the balance of the duties “in connection with” a hospital (Taxation Determination TD 2015/12). Rebatable employers An employer pays FBT on the grossed-up taxable value of fringe benefits and is entitled to claim an offsetting tax deduction (see ¶3-150). To ensure that certain non-government, non-profit employers that are unable to claim a tax deduction are not disadvantaged, these employers (commonly called “rebatable employers”) are eligible for a rebate of 47% of the amount of FBT payable, subject to a capping threshold. FBT year ending

Rebate %

31 March 2018 and later years 47%

Capping threshold $30,000

If the total grossed-up taxable value of fringe benefits provided to an employee is more than the capping threshold, a rebate cannot be claimed for the FBT liability on the excess amount. The capping threshold applies even if the rebatable employer did not employ the employee for the full FBT year. For example, if the total grossed-up value of benefits provided to an employee between October and March was $15,000, a rebate applies to all of the FBT payable for providing these benefits. Rebatable employers (non-government, non-profit organisations) include: • registered charities (other than PBIs or HPCs, or government institution charities) that are an institution (see further below) • religious, educational, scientific or public educational institutions • trade unions and employer associations • non-profit organisations established: – to encourage music, art, literature or science – to encourage or promote a game, sport or animal races – for community service purposes – to promote the development of aviation or tourism – to promote the development of Australian information and communications technology resources – to promote the development of the agricultural, pastoral, horticultural, viticultural, manufacturing or industrial resources of Australia. The FBT rebate is not available to:

• charities that are not institutions (eg the charity is a fund) • charities that are institutions established by a law of the Australian Government, a state or a territory (eg public universities, public museums and public art galleries) • registered PBIs and HPCs — these organisations are eligible for the FBT exemption. Certain entertainment benefits under salary packaging arrangements may access a separate capping threshold (see below). Registered religious institutions A “registered religious institution” (RRI) is determined by the entity being established as an institution and its registration with the ACNC. RRIs endorsed by the ATO as a registered charity (see above) are eligible for the FBT rebate. RRIs may also be eligible for FBT concessions for benefits they provide to religious practitioners, live-in carers and domestic employees. No ATO endorsement is required, but the institution must be registered with the ACNC as a charity with a sub-type “advancing religion”. A benefit provided by an RRI to an employee religious practitioner, or their spouse or child in respect of the practitioner’s pastoral duties or directly related religious activities is an exempt benefit (FBTAA s 57). “Religious practitioners” generally are ordained ministers of religion and lay persons commissioned to perform the ministry, members of religious orders and students undertaking certain religious studies or training (see TR 2019/3 for examples). Separate cap for salary packaged entertainment benefits A separate single grossed-up cap of $5,000 applies to fringe benefits that are salary packaged meal entertainments and entertainment facility leasing expenses, namely: • entertainment by way of food or drink • accommodation or travel in connection with, or to facilitate the provision of, such entertainment • entertainment facility leasing expenses. Salary packaged entertainment provided is included in the capping threshold for the FBT exemption and FBT rebate (see above). However, if the capping threshold is exceeded in a particular year, it is raised by the lesser of: • $5,000, and • the total grossed-up taxable value of salary packaged entertainment benefits. This means employers are provided with a single grossed-up cap of $5,000 per employee each FBT year for salary packaged entertainment benefits which remain eligible for concessional FBT treatment. The $5,000 cap is available even if the employer did not employ the employee for the full FBT year. The $5,000 separate cap is the grossed-up amount (see GST Ruling GSTR 2001/3). Car parking and remote area concessions A car parking fringe benefit and car parking expense payment fringe benefit are exempt from FBT when provided by registered charities, scientific institutions (other than an institution run for the purposes of profit or gain to its shareholders or members) and public educational institutions. For remote area concessions, an extended definition of remote applies to housing benefits provided for employees of a public hospital, a government body where the duties of the employee are exclusively performed in, or in connection with, a public hospital or a non-profit hospital, a hospital carried on by a non-profit society or a non-profit association that is a rebatable employer, a registered charity, a public ambulance service or a police service. Fringe benefits not included in calculation of capping thresholds

The following fringe benefits which are excluded from an employee’s individual fringe benefits amount for reporting purposes (see ¶3-155: “Reportable fringe benefits”) are not included in the calculation of the capping thresholds where they are provided by registered PBIs and HPCs, public hospitals, non-profit hospitals, public ambulance services and rebatable employers: • car parking fringe benefits • meal entertainment (not salary packaged) and entertainment facility leasing expenses (not salary packaged).

¶3-700 Other FBT concessions and caps In-house fringe benefits — tax free threshold Broadly, these are benefits of a kind that are supplied to the public (or certain classes of the public, eg the police force) in the ordinary course of the employer’s business. The first $1,000 of the aggregate of the taxable values of the following “in-house” benefits (¶3-445) provided to an employee in a year is exempt from FBT (FBTAA s 62). Some types of in-house fringe benefits include the following: • in-house property fringe benefits — generally, goods and other property provided to employees which are of a kind that the employer sells in the ordinary course of business (those valued as outlined at ¶3-445) • in-house residual fringe benefits — generally, services and other residual benefits provided to an employee which are of a kind that the employer provides in the ordinary course of business (those valued as outlined at ¶3-445) • in-house expense payment benefits — where the expenditure to which the benefit relates was incurred by an employee in acquiring property or other benefits of a kind that the employer provides in the ordinary course of business (those valued as outlined at ¶3-430). The exemption includes benefits provided to an associate of the employee (Miscellaneous Tax Ruling MT 2044). An employer who provides one or more of the above in-house fringe benefits to an employee during the FBT year may reduce the aggregate of the taxable values of the in-house fringe benefits by $1,000. If a particular fringe benefit is also eligible for another concession, the taxable value is first reduced by the other concession, and then by this concession. For example, the taxable value of an in-house residual benefit is generally 75% of the lowest price charged to the public for the same type of benefit, less any amount actually paid for the benefit. This means that anywhere up to 25% of the value of the benefit plus an additional $1,000 per employee could be exempt from FBT each year. The annual $1,000 reduction of aggregate taxable value is not available in respect of in-house fringe benefits which are provided under a salary packaging arrangement (¶3-850). Consistent with the principles outlined in Miscellaneous Taxation Ruling MT 2025 (guidelines for valuation of housing fringe benefits), a retirement village operator can apply a valuation discount of 10% on the statutory annual value of housing fringe benefits provided to live-in-managers in a retirement village (PCG 2016/14). Entertainment expense payments A reduction in the taxable value of an expense payment fringe benefit is available where the expense payment fringe benefit arises from expenditure an employee incurs in entertaining people other than the employee or associates (eg expenditure incurred by the employee on entertaining your clients). An employer may reduce the taxable value of the expense payment fringe benefit by the percentage of the expenditure incurred in entertaining the other people. No reduction in the taxable value applies under this concession if the otherwise deductible rule applies.

Remote area concessions A location is considered remote if it is not in, or adjacent to, an eligible urban area. For guidelines and the ATO classifications on whether an area is remote for FBT purposes, see “Fringe benefits tax — remote areas”: www.ato.gov.au/general/fringe-benefits-tax-(fbt)/in-detail/exemptions-and-concessions/fbt--remote-areas. The principal remote area concessions in the FBTAA are: • remote area housing benefit exemption (s 58ZC; ID 2005/156) • residential fuel reduction (s 59) • remote area loan and interest (s 60(1), (2)) • remote area rent (s 60(2A)) • remote area property benefit and (s 60(3)) • remote area residential property expense payment benefit, residential option fees, residential property repurchase consideration (s 60(4)–(6)) • remote area holiday transport (s 60A, 61; ID 2014/9: calculation of taxable value) • remote area home ownership schemes (s 65CA–65CC). Care must be given to the effectiveness of lease agreements between an employer and employee relating to a residential property either owned or leased by the employee in a remote area (Taxpayer Alert TA 2002/9). For instance, where an employee in a remote area leases a residence to the employer and then salary sacrifices rent to the employer, the employer is not entitled to the remote area housing exemption. The taxable value of housing fringe benefits arising from assistance provided to an employee in a remote area is reduced by 50%. Housing assistance includes where the employer: • pays or reimburses interest on a housing loan, or pays an option for the right to purchase a home • reimburses an employee for expenses connected with a home, or pays or reimburses rent, or • supplies or reimburses the cost of gas, electricity and other residential fuel for an employee in a remote area. The provision of transport to and from an employee’s home base and a remote area worksite is an exempt benefit and the value of certain travel benefits provided to an employee under an award or industry custom is reduced by 50% (up to a limit). Remote area home ownership schemes This concession permits the amortisation of fringe benefits provided in connection with remote area home ownership schemes. The period of amortisation is generally five to seven years. The benefits may consist of: • a discount on the purchase of a home or of land on which to build a home • a reimbursement of the cost of buying land and/or building a home, or • an option fee entitling you to first choice in repurchasing the home. There must be a restriction on the employee’s freedom to sell the house during the amortisation period. If the employer repurchases the home during the amortisation period, the unamortised balance is brought to account in that FBT year. Where an employee is forced by a contractual buy-back arrangement to suffer a loss in selling the home back to the employer, the employer may deduct 50% of that loss from the aggregate taxable values in that FBT year. (The rationale for this reduction is that any fringe benefit given

to the employee to facilitate the original purchase of the house is being offset by the loss on its resale.) Employees posted overseas Where an employee is posted overseas and is provided with travel for a holiday, the taxable value of the benefit is reduced by 50%. The reduction also applies to expatriate employees who are posted to Australia. Fringe benefits relating to the education costs of the employee’s children are exempt to the extent that the costs relate to a school term while the employee is overseas. Issues paper — remote area tax concessions and payments The Productivity Commission has released an issues paper relating to its review to determine the appropriate ongoing form and function of the zone tax offset, FBT remote area concessions and remote area allowance (www.pc.gov.au/inquiries/current/remote-tax/issues/remote-tax-issues.pdf: submissions closed on 29 April 2019).

FBT PLANNING ¶3-800 Reducing your FBT liability When recruiting employees or at employee salary reviews, an employer may, by negotiation and planning with the employees, adopt strategies so as to reduce its FBT liability or, in certain cases, have no FBT liability at all. Some strategies invariably have a tax impact on the employees affected and therefore would need to be looked at in an overall total remuneration context (ie total employment costs) with the employees. These strategies include: • replacing fringe benefits with cash salary • having employees make a contribution • providing benefits that are exempt from FBT or benefits that are not fringe benefits • providing tax-deductible benefits to employees. Appropriate declarations must also be obtained in respect of fringe benefits (see checklist below). Replacing fringe benefits with cash salary The most obvious strategy for employers is to replace employee fringe benefits with the cash equivalent in the form of salary or wages. In that case, the employer will have no FBT liability and none of the administration and time costs associated with providing fringe benefits. In addition, this will also considerably reduce some of the accounting and record-keeping requirements on the part of the employers for the impact of the GST and its interaction with FBT. However, the employer’s cost benefits should be examined with the employees concerned as they will have to pay income tax on any increased salary or wages. Cash payments are generally more tax effective for employees with a tax rate below 47% (ie the top marginal rate of 45% plus Medicare levy of 2%), except where concessional FBT treatment applies. Using employee contributions As a general rule, an employer will be able to reduce its FBT liability by obtaining a contribution from the employee, as the taxable value of a fringe benefit is reduced by the amount of the employee contribution towards the cost of the benefit. Note, however, that an employee contribution towards the cost of a particular fringe benefit can be used only to reduce the taxable value of that benefit and not the taxable value of any other fringe benefit. Example Anna receives a car fringe benefit and a loan benefit from her employer. She contributes $25 a week for the use of the vehicle

provided to her. The taxable value of that vehicle would be reduced by $1,300 ($25 × 52 weeks) and the loan benefit is unaffected.

The provision of a fringe benefit or exempt benefit can be a taxable supply for GST purposes. Accordingly, where an employee, or associate, makes a contribution for that taxable supply, GST is payable on the provision of the fringe benefit or exempt benefit. The amount of GST payable is 1/11th of the contribution (¶3-550, ¶3-950). Providing benefits that are exempt from FBT An employer who provides only exempt benefits, or benefits that are not fringe benefits, will not have an FBT liability. For example, an employer would not be liable for FBT for providing the following items to employees (limited to one item of each type per employee, per FBT year, unless it is a replacement item): • a mobile phone or car phone (used mainly in employment) • protective clothing • office tools (eg brief case, calculator) • computer software for use in employment • laptop computer (notebook), limited to one purchase or reimbursement per employee per year (¶3600). Minor benefits are generally exempt from FBT. This is the case where the value of the benefit is less than $300 and it would be unreasonable to treat it as a fringe benefit, eg it is provided infrequently. Providing benefits that are deductible An employer may not have an FBT liability if it pays for or reimburses an expense that its employees would otherwise have been able to claim as a tax deduction under the income tax law (

¶3-500). Preparing for FBT year end Issues that employers should bear in mind when preparing for each FBT year end include the following: • identifying and collating all the possible benefits provided to employees and their associates (eg expense payments, gifts, entertainment) via a review of staff remuneration and salary packages • ensuring that all invoices and receipts have obtained receipts for an unreimbursed expenditure relating to any fringe benefits provided, including those for car expenses incurred such as petrol, insurance and registration, and • obtaining declarations from employees (see below). Ensure declarations are obtained In each FBT year, the employer must obtain all employee declarations no later than the day on which the FBT return for the year is due (see below), such as: • airline transport benefit declaration • employee’s car declaration • employment interview or selection test declaration — transport in employee’s car • expense payment benefit declaration • fuel expenses declaration • living-away-from-home declaration • loan fringe benefit declaration • no private use — expense payments declaration • no private use — residual benefits declaration • declaration of car travel to work-related medical examination, medical screening, preventative health care, counselling or migrant language training • property benefit declaration • recurring benefits declaration — recurring expense payment fringe benefit, property fringe benefit, residual fringe benefit • relocation transport declaration • remote area holiday transport declaration • residual benefit declaration • residual benefit declaration — vehicles other than cars • temporary accommodation declaration • declarations regarding the otherwise deductible rule. Lodging an FBT return An employer that has an FBT liability for the FBT year is required to lodge an FBT return with the ATO by 21 May each year (this is deferred to 25 June 2020 for the 2019/20 return:

www.ato.gov.au/General/COVID-19/Support-for-tax-professionals). No FBT return is required if the fringe benefits taxable amount is nil, but the employer must lodge a Notice of non-lodgment with the ATO. Detailed ATO instructions for the 2020 FBT return are set out in www.ato.gov.au/Forms/2020-Fringebenefits-tax-return-instructions. Record-keeping exemption Employers must put in place a reliable and comprehensive record-keeping system which ensures that all relevant documentation and records are obtained and held on file at the time the FBT return is due for lodgment. Employers may elect not to keep records for an FBT year, but to have their FBT liability for that FBT year determined using the total taxable value of fringe benefits provided in an earlier base year in which FBT records were kept (FBTAA s 135C). To be eligible for the record-keeping exemption, a base year needs to be established and, during the FBT year immediately before the current year, the employer has not received an ATO notice requiring the employer to resume record-keeping. An employer that is not a government body or an income tax-exempt organisation can elect to apply the record-keeping exemption if: • FBT records have been kept for the base year • the employer’s aggregate fringe benefits amount provided in the current year is not 20% more than that in the base year • the employer’s aggregate fringe benefits amount in the base year does not exceed the exemption threshold for the FBT year ($8,853 for 2020/21, $8,714 for 2019/20 year). FBT matters which attract the ATO’s attention The matters below will likely attract attention when the ATO is determining compliance with the FBT obligations: • failing to report car fringe benefits, incorrectly applying exemptions for vehicles or incorrectly claiming reductions for these benefits • mismatches between the amount reported as an employee contribution on an FBT return and the income amount on an employer’s tax return • claiming entertainment expenses as a deduction but incorrectly reporting them as a fringe benefit or incorrectly classifying such expenses as sponsorship or advertising • incorrectly calculating car parking fringe benefits due to significantly discounted market valuations, or using non-commercial parking rates or not having adequate evidence to support the calculated rates • not applying FBT to the personal use of an organisation’s assets provided for the personal enjoyment of employees or associates • not lodging FBT returns (or lodging them late) to delay or avoid payment of tax (www.ato.gov.au/Business/Privately-owned-and-wealthy-groups/What-attracts-our-attention).

¶3-850 Salary packaging or sacrifice Salary packaging and salary sacrifice arrangements are discussed in detail in Chapter 10. A “salary packaging arrangement” (SSA) is defined to mean an arrangement where the employee receives a benefit: • in return for a reduction in salary or wages that would not have happened apart from the arrangement, or • as part of the employee’s remuneration package, and the benefit is provided in circumstances where it

is reasonable to conclude that the employee’s salary or wages would be greater if the benefit were not provided (FBTAA s 136(1)). An SSA is also commonly referred to as a total remuneration packaging arrangement. The ATO’s approach is to treat SSAs as “ineffective SSAs” or “effective SSAs” (Taxation Ruling TR 2001/10). This is to distinguish between arrangements where the employee is considered to have derived the salary sacrifice amount as assessable income and where there is no derivation of the cash salary. An “effective SSA” arises where an employee agrees to receive part of their remuneration as benefits before the employee has earned the entitlement to receive that amount as salary or wages. In contrast, an “ineffective SSA” arises where an employee directs that an existing entitlement to receive salary or wages that has been earned is paid in the form of non-cash benefits. The test, therefore, is whether entitlement to the amount sacrificed has been earned. Generally, an entitlement arises when services are performed, and not when payment for the services is received. The period to which the payment relates is, therefore, critical. Under an “ineffective SSA”, the benefits provided to an employee are considered to be payments of salary or wages and remain part of the employee’s assessable income, while benefits provided under an “effective SSA” are treated according to the type of benefit provided (eg fringe benefit, superannuation contribution, employee share plan shares) with the appropriate FBT rules applying. It may be possible for employees to reduce their salary and wages below the minimum entitlement under an industrial award in certain circumstances. The AAT has held that an SSA under an employee share trust arrangement was a mere redirection of assessable income (Yip v FC of T 2011 ATC ¶10-214). In that case, the SSA amounts were ordinary income of the employee under constructive receipt rules, ie the “salary sacrifice” request merely meant the employer had dealt with the amounts in accordance with the employee’s direction. The arrangement provided no tangible benefit to the employee other than the deferral of income tax. Although the AAT did accept the taxpayer’s right to flexibility in receiving remuneration partly as cash and as benefits, there was no “benefit” in this situation and, therefore, the SSA amounts remained the employee’s income. What type of benefits can be included? All non-cash benefits can be covered by an SSA. The more common types of benefits include: • employer superannuation — employer superannuation contributions to a complying superannuation fund for the benefit of an employee are not fringe benefits (and not subject to FBT), except those made for an associate of an employee • fringe benefits — such as car fringe benefits and expense payment fringe benefits (eg payment of an employee’s loan repayments, school fees, child care costs and home telephone costs) • exempt benefits — such as expense payment, property or residual benefits arising for the following items commonly provided: a notebook computer, laptop computer or similar portable computer (exemption is limited to one a year), or a mobile phone or car phone (exemption if primarily for use in employee’s employment) (¶3-600). Donations made to deductible gift recipients by an employee under an SSA do not result in an employer incurring an FBT liability. No concessions for certain benefits accessed through an SSA Certain tax concessions are lost where the fringe benefits below are accessed through an SSA on or after 22 October 2012: • the concessional taxable value calculation method for in-house expense payment benefits, in-house property benefits or in-house residual benefits. Instead, the taxable value of the benefit is based on the “notional value” of the benefit • the residual benefits exemption for employee transport from home to work (for employers in the transport business), and

• the annual $1,000 reduction of aggregate taxable value in respect of in-house fringe benefits (see ¶3700). Caps on FBT salary sacrificed meal entertainment benefits and entertainment facility leasing expenses Salary packaged meal entertainment benefits from 1 April 2016 are: • subject to a separate single grossed-up cap of $5,000, and benefits exceeding the $5,000 cap will count towards an existing FBT exemption or rebate cap • reportable fringe benefits and must be included on a payment summary where the reporting threshold is exceeded (these benefits cannot have their taxable value calculated using the elective valuation rules).

¶3-900 Impact on employees of reportable fringe benefits If the grossed-up taxable value of certain fringe benefits provided to an employee exceeds $3,773 in an FBT year (ie the $2,000 taxable value threshold grossed-up by 1.8868), the employer is required to report the grossed-up taxable value of the fringe benefits on the payment summary given to the employee (see “Working out the reportable amount” below). This reporting is to ensure that employees receiving fringe benefits (including via salary packaging) cannot avoid surcharges and child support obligations or have access to certain tax concessions (see “Impact of reportable fringe benefits on other tax concessions” below). Benefits provided to the employee’s associates (eg the spouse or children) in respect of the employee’s employment are also included as the employee’s fringe benefits. In addition, if the employee shares a fringe benefit with other employees, the employer will need to work out the portion of the taxable value that reasonably reflects the amount of the benefit provided to each employee, based on the employee’s usage of the benefit. Impact of reportable fringe benefits on other tax concessions Reportable fringe benefits are not included in an employee’s assessable (or taxable) income and do not affect the amount of standard Medicare levy payable. However, the employee’s reportable fringe benefits total (ie the sum of the reportable fringe benefits amounts in respect of all employment) is taken into account for various purposes under the tax laws, for example, to determine the employee’s: • eligibility to claim a deduction for personal superannuation contributions, a tax rebate for spouse superannuation contributions, or entitlement to government co-contributions (¶4-220 to ¶4-265) • liability for the Medicare levy surcharge (¶3-950, ¶20-020) • Higher Education Loan Program (HELP) repayments (¶20-080) • child support obligations (¶18-705) • entitlement to certain income-tested government benefits and concessions (see “Family Assistance payments” in ¶6-350). The interaction of FBT with other taxes generally is discussed in ¶3-950. Working out the reportable amount Under the reportable fringe benefits arrangements, if an employee’s reportable fringe benefits amount in an FBT year (1 April to 31 March) exceeds $3,773 (ie $2,000 grossed-up at 1.8868), this amount is reported on the employee’s payment summary for the corresponding income year. The grossing-up ensures the value of fringe benefits is commensurate with other forms of income on the payment summary. As income tax is not paid on fringe benefits, the grossed-up taxable value of a benefit includes the amount of income tax that the employee would have paid if cash salary, rather than the fringe benefit, had been received. For grossing-up purposes, the FBT rate used is equal to the highest

marginal rate of income tax plus Medicare levy, ie grossing-up is calculated using the lower Type 2 grossup rate of 1.8868 (¶3-155, ¶3-300). Example In the 2020/21 FBT year, Michael’s employer provides him with a car where the taxable value of the car fringe benefit is $2,500. Michael and his wife also stay in employer-provided accommodation, with a taxable value of $800, several times during the year. The taxable value of the fringe benefits provided to Michael for the year amounts to $3,300. An amount of $6,226 ($3,300 grossed-up by 1.8868) is the reportable fringe benefits amount for Michael and this amount is reported in Michael’s payment summary for the relevant income tax year.

Reducing impact of reportable fringe benefits An employee may consider the following options to reduce the amount of reportable fringe benefits: • substitute or modify fringe benefits for cash salary • make a contribution that reduces the taxable value of the fringe benefit • receive only fringe benefits that are not reportable (eg car parking benefits other than car parking expense payment benefits, entertainment by way of food or drink, and benefits associated with that entertainment such as travel and accommodation) (¶3-155) • receive only benefits which are exempt from FBT (eg exempt benefits used primarily for work and minor benefits) (¶3-600).

¶3-950 Fringe benefits — interaction with other taxes The general scheme of the FBT and income tax laws is that monetary remuneration, including most allowances, is subject to income tax in the employee’s hands, while non-cash benefits are generally subject to FBT but not income tax. Therefore, a fringe benefit that is taxable under the FBTAA, or is specifically exempted from FBT (except for certain car expense payment benefits), is free from income tax. An employer’s fringe benefits taxable amount is calculated by classifying fringe benefits into two types of aggregate fringe benefits amounts — Type 1 aggregate fringe benefits amount, being those fringe benefits where there is an entitlement to a GST input tax credit to the provider, and Type 2 aggregate fringe benefits amount, being those fringe benefits where there are no entitlements to GST input tax credits to the provider (¶3-300). Guidelines on the operation of the FBT gross-up formula to take into account the effect of input tax credits (where applicable) in respect of GST paid on some fringe benefits are set out in Taxation Ruling TR 2001/2. Income tax and FBT Employers can claim an income tax deduction for the cost of providing fringe benefits. The amount deductible is the GST-exclusive value if GST input tax credit is available on the acquisition of the fringe benefit (see below), or the full amount paid or incurred if GST input tax credit is not available. If either a recipient’s payment or a recipient’s contribution (as consideration for a taxable supply) is added to an employer’s assessable income, such a payment or contribution will be added for income tax purposes at the GST-exclusive value. Where the otherwise deductible rule (¶3-500) applies, the calculation of the taxable value of a fringe benefit is reduced by the hypothetical deduction to which the employee would have been entitled had the employee incurred the expense. In this case, the employer takes into account the GST-inclusive value, as applicable (TR 2001/2, para 24–26). The deduction is available even though no deduction would have been allowed had the employee incurred the expenditure (eg entertainment, club fees, expenditure on leisure facilities and boats, travel expenses of accompanying relatives). Further, an employer is assessable for income tax on amounts of FBT reimbursed or amounts received to reduce the taxable value of fringe benefits provided.

Employers can claim an income tax deduction for its FBT payment (¶3-050). Medicare levy surcharge Medicare levy is payable by resident individual taxpayers based on their taxable income or combined family taxable income above a threshold amount. A Medicare levy surcharge applies to high-income taxpayers who do not have appropriate private patient hospital cover (¶1-075). Income for surcharge purposes includes a taxpayer’s reportable fringe benefits total (¶3-155). GST For the 2020/21 FBT year (where the GST rate is 10% and the FBT rate is 47%), if an employer (benefit provider) is entitled to claim an input tax credit in respect of GST paid on goods or services acquired in order to provide fringe benefits (a Type 1 fringe benefit), the Type 1 gross-up rate of 2.0802 applies when calculating the FBT liability. Where there is no entitlement to claim an input tax credit (a Type 2 fringe benefit), the Type 2 gross-up rate of 1.8868 applies (¶3-300). The classification of a fringe benefit (including an excluded fringe benefit) as a Type 1 fringe benefit does not depend on the extent of the GST input tax credit entitlement to the provider or whether input tax credit is subsequently claimed. The test is whether there is any entitlement to a GST input tax credit. A fringe benefit (including an excluded fringe benefit) that is either wholly GST-free or input taxed cannot be classified as a Type 1 fringe benefit; consequently, it must be a Type 2 fringe benefit. Some fringe benefits that are supplied do not entitle the provider to GST input tax credits (ie fringe benefits where the acquisition does not meet the requirements of a creditable acquisition under A New Tax System (Goods and Services Tax) Act 1999 (GST Act) s 11-5). Such a benefit cannot be classified as a Type 1 fringe benefit; consequently, it must be a Type 2 fringe benefit (TR 2001/2 para 17–18). If an employee makes a contribution or payment towards the cost of the fringe benefit provided, this is consideration for a taxable supply for GST purposes and the employer is liable to pay GST based on 1/11th of the contribution (see “Employee contributions” below). A GST-creditable benefit arises where either the employer or provider of the fringe benefit (or another member of the same GST group) is entitled to an input tax credit under the GST Act because of the provision of the benefit. A benefit provided in respect of an employee’s employment is also a GST-creditable benefit if: • the benefit consists of a “thing”, as defined in the GST Act (or an interest in or a right over such a thing, a personal right to call for or be granted any interest in or right over such a thing, a licence to use or any other contractual right exercisable over such a thing) • the thing was acquired or imported and either the employer or provider of the fringe benefit is entitled to an input tax credit under the GST Act because of the acquisition or importation. Employee contributions Where an employee or associate is a recipient of a fringe benefit or exempt benefit (ie a taxable supply for GST purposes) and makes a “contribution” or payment (other than a contribution of services as an employee) to the employer for the supply of the benefit (¶3-550), GST is payable on that supply by the employer. The contribution or payment is the price for that supply; therefore, 1/11th of that amount is the GST payable by the employer. For FBT purposes, the taxable value of a fringe benefit is reduced by the full amount of the contribution the employee makes in relation to the benefit, regardless of whether the employer has to remit any GST for that contribution. Where the employee makes a contribution by paying to a third party (eg the purchase of fuel or oil in respect of a car fringe benefit), no further GST is payable by the employer for that type of employee contribution. This is because GST has already been paid at the time of the supply to the employee, or associate, from the third party.

Contributions in respect of GST-free or input taxed supplies are not taxable supplies and no GST would be payable for any contribution towards these supplies. An employer that is not registered (or not required to be registered) for GST does not have to pay GST on an employee’s contribution. Example Janet’s employer (Beauty Pty Ltd) provides her with a car that she uses wholly for private purposes. Beauty Pty Ltd is registered for GST. In the FBT year, Janet contributed $3,300 (as an employee’s payment) directly to her employer towards the running costs of the car. Beauty Pty Ltd will have to remit $300 (1/11th of $3,300) of that contribution for GST and will deduct the full $3,300 of the contribution when calculating the taxable value of the car fringe benefit. Janet also pays some of the car’s running costs (fuel, oil and servicing) amounting to $2,200 that FBT year. Although the $2,200 is a recipient’s payment for FBT purposes, it is not a contribution for the supply of the benefit for GST purposes. Beauty Pty Ltd is not liable to GST for that payment, but is required to deduct the full $2,200 when calculating the taxable value of the car fringe benefit. Therefore, when calculating the taxable value of the car fringe benefit provided to Janet, Beauty Pty Ltd will deduct $5,500, being the total of Janet’s payments ($3,300 + $2,200).

Interaction with personal services income rules The taxable value of fringe benefits provided to an employee is reduced by the amount of a payment that is non-deductible because of the personal services income (PSI) rules so as to avoid double taxation. Under the PSI rules in the ITAA97, a payment to an associate of a service provider for performing ancillary work is not deductible. However, if FBT is payable on the value of the benefit, this will result in double taxation (ie income tax and FBT). In such a case, FBT will only be payable on the value of the benefit that is deductible to the provider.

SUPERANNUATION The big picture

¶4-000

Superannuation in Australia Objective of superannuation

¶4-100

Superannuation funds

¶4-110

Other superannuation entities

¶4-120

Regulation of superannuation entities

¶4-150

Superannuation and bankruptcy laws

¶4-160

Contributions to superannuation funds Superannuation contributions

¶4-200

Contributions made to a fund

¶4-203

Acceptance of contributions

¶4-205

Employer superannuation contributions

¶4-210

Employer contributions following salary sacrifice

¶4-215

Personal superannuation contributions

¶4-220

First Home Super Saver scheme

¶4-222

Downsizer contributions by individuals aged 65 and over

¶4-223

Tax on concessional contributions of high-income earners

¶4-225

Transfer balance cap rules

¶4-227

Transfer balance account

¶4-228

Transfer balance cap

¶4-229

Excess transfer balance determinations

¶4-230

Excess transfer balance tax

¶4-231

Modified transfer balance cap rules for capped defined benefit income streams ¶4-232 Total superannuation balance

¶4-233

Excess concessional contributions

¶4-234

Penalties imposed on excess concessional contributions

¶4-235

Excess non-concessional contributions

¶4-240

Tax treatment of excess non-concessional contributions

¶4-245

Excess contributions may be disregarded or reallocated to another year

¶4-250

Splitting superannuation contributions with a spouse

¶4-260

Government co-contribution for low income earners

¶4-265

Low income superannuation tax offset

¶4-270

Tax offset for spouse contributions

¶4-275

Taxation of contributions in the hands of the fund

¶4-280

Taxation of funds and RSA providers Taxation of funds and RSA providers

¶4-300

Complying or non-complying?

¶4-310

Taxation of complying superannuation funds

¶4-320

Taxation of non-complying funds

¶4-340

Taxation of PSTs and RSA providers

¶4-360

Tax on “no-TFN contributions income”

¶4-390

Withdrawal of superannuation benefits Withdrawal of superannuation benefits

¶4-400

Superannuation benefits paid to a member

¶4-420

Superannuation death benefits

¶4-425

Roll-over superannuation benefits

¶4-430

Superannuation benefits paid to former temporary residents

¶4-435

Transfer of superannuation between Australia and New Zealand

¶4-440

Superannuation income streams which commenced before 1 July 2007

¶4-450

Superannuation split on relationship breakdown

¶4-480

Superannuation guarantee scheme Superannuation guarantee scheme

¶4-500

Quarterly payment of SG amounts

¶4-510

Employees covered by SG scheme

¶4-520

How much does an employer have to contribute?

¶4-540

Liability to SG charge if insufficient contributions

¶4-560

Choice of fund rules

¶4-580

Foreign superannuation funds Australian or foreign superannuation funds

¶4-600

Superannuation benefits from foreign superannuation funds

¶4-650

¶4-000 Superannuation

The big picture Superannuation funds Superannuation is all about individuals saving for their retirement, and superannuation funds are the most common entity used for this purpose. • The objective of superannuation, proposed to be “to provide income in retirement to substitute or supplement the Age Pension”, is to be enshrined in legislation as a stand-alone Act .................................... ¶4-100 • A superannuation fund is a fund set up to provide benefits to its members on retirement or death benefits to dependants on the member’s death .................................... ¶4-110

• Retirement savings accounts (RSAs), pooled superannuation trusts (PSTs) and approved deposit funds (ADFs) are other superannuation vehicles .................................... ¶4-120 • Superannuation funds, other than self managed superannuation funds (SMSFs), are primarily regulated by the Australian Prudential Regulation Authority (APRA), but the Australian Securities and Investments Commission (ASIC) and the Australian Tax Office (ATO) are also involved in regulating their operations. SMSFs are primarily regulated by the ATO .................................... ¶4-150 • The Australian Financial Complaints Authority took over the Superannuation Complaints Tribunal’s role in settling complaints about superannuation from 1 November 2018.................................... ¶4-150 Superannuation contributions • There are two types of contributions: concessional (deductible) contributions and nonconcessional (non-deductible) contributions .................................... ¶4-200 • Employer contributions to the superannuation small business clearing house may be treated as made, and therefore deductible, in the year they are made to the clearing house if the conditions in ATO guideline Practical Compliance Guideline PCG 2020/6 are met .................................... ¶4-203 • Contributions can be made to a superannuation fund if the fund is allowed to accept the contributions. Subject to age restrictions and a work test, a superannuation fund can generally accept contributions from employers on behalf of employees or from members for themselves or for someone else such as a spouse .................................... ¶4-205 • Individuals aged 65 and 66 are exempted from needing to satisfy the work test from 1 July 2020 .................................... ¶4-205 • From 1 July 2019, individuals aged 65 to 74 with a total superannuation balance below $300,000 may be able to make voluntary contributions for 12 months from the end of the financial year in which they last met the work test .................................... ¶4-205 • A fund may not accept contributions from a member if the member’s Tax File Number (TFN) is not quoted to the fund .................................... ¶4-205 • An employer is allowed a tax deduction for contributions on behalf of an employee to a complying superannuation fund, provided certain conditions are satisfied .................................... ¶4-210 • An employer is entitled to a deduction for superannuation guarantee (SG) contributions for an employee regardless of the employee’s age .................................... ¶4-210 • Employer superannuation contributions resulting from a salary sacrifice arrangement cannot, from 1 January 2020, count as SG contributions .................................... ¶4-215 • Members, including employees, are generally entitled to a tax deduction for personal contributions if certain conditions are satisfied .................................... ¶4-220 • Individuals saving for their first home may be able to contribute up to $30,000 into superannuation and withdraw the contributions to use as a deposit on a home .................................... ¶4-222 • Individuals aged at least 65 may be able to make a non-concessional contribution to a complying superannuation fund of up to $300,000 from the proceeds of selling their home .................................... ¶4-222

• Concessional contributions are generally taxed at 15% but may also be liable to an additional 15% Division 293 tax if the contributor’s income exceeds $250,000 .................................... ¶4225 • A transfer balance cap ($1.6m for 2020/21) limits the amount of capital an individual can transfer to the retirement phase to support a superannuation income stream that benefits from the earnings tax exemption .................................... ¶4-227 • An individual may be liable to excess transfer balance tax if their transfer balance exceeds the $1.6m cap .................................... ¶4-227 • An individual whose transfer balance exceeds their transfer balance cap may be required to remove amounts from superannuation or transfer them to the accumulation phase .................................... ¶4-227 • Modified transfer balance cap rules apply for certain capped defined benefit income streams .................................... ¶4-232 • An individual’s “total superannuation balance” is used to value their superannuation interests and determine their entitlement to various superannuation concessions .................................... ¶4233 • A member’s share of the outstanding balance of certain limited recourse borrowing arrangements (LRBAs) may be included in their total superannuation balance if the borrowing arises under a contract entered into on or after 1 July 2018 .................................... ¶4-233 • The basic concessional contributions cap is $25,000 for 2020/21 .................................... ¶4-234 • Individuals who do not fully use their concessional contributions cap from 2018/19 may be able to make catch-up contributions in later years .................................... ¶4-234 • An individual’s excess concessional contributions are included in their assessable income and taxed at their marginal rate. The individual is also liable to excess concessional contributions charge .................................... ¶4-235 • An individual may apply to have excess concessional contributions released from superannuation .................................... ¶4-235 • An individual is not allowed to make non-concessional contributions if their total superannuation balance for the year exceeds the transfer balance cap ($1.6m for 2020/21) .................................... ¶4-240 • The non-concessional contributions cap is $100,000 for 2020/21 .................................... ¶4-240 • An individual who is aged under 65 may be able to bring forward non-concessional contributions for the next two years if their total superannuation balance is less than the transfer balance cap ($1.6m for 2020/21) .................................... ¶4-240 • A Bill before Parliament proposes that individuals aged 65 and 66 whose non-concessional contributions exceed $100,000 from 1 July 2020 may be eligible to access the bring forward arrangements........................................................................ ¶4-240 • Excess non-concessional contributions tax may be payable by a member whose nonconcessional contributions exceed the non-concessional contributions cap .................................... ¶4-245 • To avoid liability to excess non-concessional contributions tax, a member may elect to withdraw excess non-concessional contributions .................................... ¶4-245

• Penalties imposed on an individual who has excess contributions in a year may be reduced if the Commissioner makes a determination to disregard contributions or reallocate them to another year .................................... ¶4-250 • Concessional contributions made by an employer for a member or made by the member personally may be split with the member’s spouse .................................... ¶4-260 • Low income taxpayers may be entitled to a government co-contribution to match their undeducted personal contributions if their non-concessional contributions for the year do not exceed $100,000 and their total superannuation balance is less than $1.6m .................................... ¶4-265 • Low income taxpayers may be entitled to a low income superannuation tax offset .................................... ¶4-270 • Persons who contribute on behalf of a low income or non-working spouse may be entitled to a tax offset for their contributions .................................... ¶4-275 Taxation of superannuation funds • APRA, or the ATO in the case of an SMSF, issues a notice that a superannuation fund is a complying superannuation fund if it satisfies certain requirements. It remains a complying fund until a notice is issued that it is non-complying .................................... ¶4-310 • For 2020/21, complying superannuation funds are subject to the concessional tax rate of 15% on most of their income whereas non-complying funds are taxed at 45% .................................... ¶4320 and ¶4-340 • The taxable income of superannuation funds includes taxable contributions, investment income, dividends and capital gains, but does not generally include roll-overs from other superannuation funds or income on assets out of which pensions are paid .................................... ¶4-320 • Superannuation funds must pay additional tax on their “no-TFN contributions income”, but a tax offset may be allowed if the individual’s TFN is later quoted to the fund .................................... ¶4-390 Superannuation benefits • Contributions (and earnings on contributions) are generally required to be preserved in a superannuation fund until the member satisfies a condition of release such as retiring after reaching preservation age, suffering from a terminal illness or reaching 65 years of age .................................... ¶4-400 • A special condition of release allows an individual who is adversely affected by the economic effects of COVID-19 to apply up to 30 June 2020 to have $10,000 released on compassionate grounds during the 2019/20 financial year and to apply again from 1 July 2020 to 31 December 2020 for a further $10,000 to be released during the 2020/21 financial year .................................... ¶4-400 • Superannuation benefits paid to a member, whether in the form of a lump sum or an income stream, from a source that has been taxed in the fund are generally tax-free for members aged 60 and over. Tax is payable (but at concessional rates) if a superannuation benefit is paid to a member aged under 60 or if it is paid from a source that has not been taxed in the fund .................................... ¶4-420 • An individual may be liable to additional tax if they receive a pension in excess of $100,000 from a defined benefit income stream that has commutation restrictions .................................... ¶4420

• Superannuation death benefits paid to a dependant are tax-free if paid as a lump sum. A benefit that is paid as an income stream is tax-free if either the deceased or the dependant is aged at least 60 at the time of death. Superannuation death benefits paid to non-dependants are taxed and must generally be paid as a lump sum .................................... ¶4-425 • Superannuation benefits rolled over into a superannuation fund or to purchase a superannuation annuity are generally tax-free at the time of the roll-over. For 2020/21, if the roll-over benefit includes an untaxed roll-over amount in excess of $1.565m, 47% tax is payable on the excess amount .................................... ¶4-430 • Special withholding tax rates apply to superannuation benefits paid to former temporary residents who have left Australia .................................... ¶4-435 • Superannuation may be transferred between Australian complying superannuation funds and New Zealand KiwiSaver schemes .................................... ¶4-440 • Spouses whose relationship has broken down may split their superannuation entitlements, either by agreement or by court order .................................... ¶4-480 Superannuation guarantee scheme • Single Touch Payroll reporting applies to all employers from 1 July 2019 regardless of the number of their employees .................................... ¶4-510 • Each quarter, employers must make SG contributions to a complying superannuation fund on behalf of their employees, other than for excluded employees .................................... ¶4-520 • From 1 January 2020, an employee who receives income from multiple employers can apply to the Commissioner for an employer shortfall exemption certificate which would exempt one or more of the employee’s employers from making SG contributions for the employee .................................... ¶4-520 • From 1 January 2020, salary sacrifice contributions do not count in calculating whether an employer has complied with their SG obligations and cannot reduce the earnings based upon which SG obligations are calculated .................................... ¶4-540 • The minimum level of SG support for SG quarters commencing on or after 1 January 2020 is calculated on an employee’s “ordinary time earnings base” .................................... ¶4-540 • An employer covered by an employer shortfall exemption certificate has a maximum contribution base of nil in relation to an employee for the quarter to which the certificate relates .................................... ¶4-540 • Employers who fail to make the required superannuation contributions are liable to an SG charge .................................... ¶4-560 • Directors of companies with unpaid SG charge liabilities may be personally liable .................................... ¶4-560 • An SG amnesty that runs from 24 May 2018 to 7 September 2020 allows employers to selfcorrect certain underpayments of SG amounts without incurring additional penalties that would normally apply .................................... ¶4-560 • Employers must, in many cases, give employees a choice of fund into which their SG contributions are paid and are penalised if they fail to do so .................................... ¶4-580 • A Productivity Commission report recommends major changes to the way SG contributions for members who do not choose a fund are allocated to a default superannuation fund

.................................... ¶4-580 • A Bill proposes that, where an employee is employed under an enterprise agreement or workplace determination made on or after 1 July 2020, the employer will be required to offer choice of fund to new employees .................................... ¶4-580 Foreign superannuation funds • A foreign superannuation fund is generally not entitled to taxation concessions in respect of fund income and deductions .................................... ¶4-600 • The tax treatment of payments received from foreign superannuation funds depends on when and how the payment is made and the amount of the payment .................................... ¶4-650

SUPERANNUATION IN AUSTRALIA ¶4-100 Objective of superannuation The government announced in the 2016 Federal Budget that the objective of the superannuation system would be enshrined in legislation. A Bill to achieve this — the Superannuation (Objective) Bill 2016 — had not been passed by the time parliament was prorogued for the 2019 federal election. A new Bill would need to be introduced for the proposal to proceed. The 2016 Bill proposed that the primary objective of the superannuation system is “to provide income in retirement to substitute or supplement the age pension”. This objective clarifies that superannuation is intended to assist individuals to support themselves by providing income to meet their expenditure needs in retirement. Subsidiary objectives would provide a framework for assessing whether particular superannuation legislation is compatible with the primary objective. Various subsidiary objectives of the superannuation system have been proposed, including: • to facilitate consumption smoothing over the course of an individual’s life • to manage risks in retirement, and • to alleviate fiscal pressures on the Australian Government from the retirement income system.

¶4-110 Superannuation funds Various superannuation entities hold funds intended to be used in a person’s retirement. The most common is a superannuation fund, but there are also retirement savings accounts, approved deposit funds, pooled superannuation trusts and eligible roll-over funds (¶4-120). A “superannuation fund” can broadly be described as an “indefinitely continuing fund” set up to provide retirement benefits to members or death benefits to dependants on the death of a member. An offshore trust (called the “Samoan superannuation fund”) was held not to be a superannuation fund in LLUN v FC of T 2018 ATC ¶1-095 because, although it was an indefinitely continuing fund, it could not be said that its sole purpose was the provision of retirement benefits. This was because the trust deed allowed benefits to be paid to a member before their retirement and the entity described in the trust deed as the “principal employer” did not actually have employees. A superannuation fund is established by governing rules (a trust deed for a private sector fund and legislation for a public sector fund) and is administered by trustees appointed under the deed or legislation. The governing rules specify who may make contributions to the fund, who can receive benefits and when, and how benefits are calculated.

Benefits may be paid as a lump sum or an income stream or as a combination of the two. There are generally two types of superannuation fund: • an “accumulation fund” (sometimes called a “defined contribution fund”), where the superannuation benefit is based on contributions and earnings on contributions, minus taxes and fees, and the member bears the risk, and • a “defined benefit fund”, where the superannuation benefit is based on a formula tied to factors such as age and salary at retirement and period of membership, and the employer bears the risk. Complying superannuation funds Concessional tax treatment, eg taxation at the rate of 15%, applies to a complying superannuation fund (¶4-320). To be a complying superannuation fund, a fund must: • be a “resident regulated superannuation fund”, that is a fund whose trustees have elected that the fund will be regulated under the Superannuation Industry (Supervision) Act 1993 (SISA) and that is an Australian superannuation fund (¶4-600), and • satisfy certain conditions relating, for example, to trustee duties, acceptance of contributions and payment of benefits, investment of funds and compliance with regulatory standards. In order to be a regulated fund, a fund must have either: • a corporate trustee, or • individual trustees and a trust deed which specifies that the sole or primary purpose of the fund is to provide pensions (although this does not prevent members from being given the option to commute benefits to a lump sum). An election to be a regulated superannuation fund cannot be revoked. Complying funds receive notification of their complying status from APRA (or, in the case of an SMSF, from the ATO), and this entitles them to concessional tax treatment (¶4-300). Complying superannuation funds (which include RSA providers) may accept SG contributions for their employees (¶4-500) and, together with ADFs, may accept roll-over superannuation benefits (¶4-430). ADFs and RSAs are discussed at ¶4-120. A superannuation fund that is not a complying fund is a non-complying superannuation fund and is taxed at 45%. Small superannuation funds A small superannuation fund (one with fewer than five members) is exempted from some of the prudential requirements imposed on other funds by SISA. Small superannuation funds are sometimes referred to as do-it-yourself (DIY) funds because decision making rests with individuals who wish to maintain control over their family’s superannuation savings. A small superannuation fund may be: • a self managed superannuation fund (SMSF) which is regulated by the ATO (see below), or • a small APRA fund which has fewer than five members but does not satisfy the definition of an SMSF and is regulated by APRA. Self managed superannuation funds Broadly, an SMSF (¶5-020) is a superannuation fund: • with fewer than five members • where each member is a trustee (or director of the trustee company) and there are no other trustees, and

• where no member is an employee of another member (or of an associated person), unless they are related. These rules are varied where a fund has only one member. A fund with only one member may be an SMSF if: • it has a corporate trustee and the member is either: – the sole director, or – one of two directors and not an employee of the other director unless they are related, or • it has two individual trustees and the member is: – one of the trustees, and – not an employee of the other trustee (unless they are related). Regardless of the number of members, a fund can generally only be an SMSF if no trustee receives remuneration for services performed in relation to the fund. The member/trustee relationship needs to be monitored to ensure it continues to satisfy the legislative requirements. If the member/trustee link is broken, or the fund otherwise fails to meet the SMSF conditions, a trustee must notify the ATO within 21 days. Failure to comply with the SMSF rules may cause a trustee to be penalised (¶5-050). SMSFs are regulated by the ATO. The ATO has the same investigative powers in respect of SMSFs as APRA has in respect of other regulated superannuation funds and administers largely similar rules. The primary aim of the ATO in relation to SMSFs is to ensure that they: • comply with the relevant provisions of SISA • are administered in a manner consistent with retirement income policy, and • use superannuation money for appropriate retirement purposes. Superannuation funds with fewer than five members that do not meet the SMSF definition (“small APRA funds”) are regulated by APRA rather than the ATO. The government introduced legislation into Parliament in February 2019 — the Treasury Laws Amendment (2019 Measures No 1) Bill 2019 — that proposed the maximum number of allowable members of an SMSF be increased from four to six. This proposal was removed from the Bill before the Bill was passed by Parliament in April 2019. The proposal to increase the maximum number of SMSF members remains government policy, although it has not yet been enacted. SMSFs are discussed in detail in Chapter 5. Defined benefit funds Some superannuation funds operated by large employers and some public sector funds provide defined benefits, at least on retirement or death. Technically, a “defined benefit fund” is a superannuation fund that has at least one defined benefit member. A defined benefit member is a person whose benefit is calculated, wholly or in part, by reference to: • the amount of the member’s salary at a particular date, being the date of the member’s termination of employment or retirement or an earlier date, or the member’s salary averaged over a period before retirement, and/or • a specified amount. Example Examples of defined benefits are: – a benefit on death equal to five times salary at the date of death, and

– a lump sum retirement benefit equal to 15% of final average salary (salary averaged over the three years immediately preceding the date of retirement) for each year of service with the company.

With a defined benefit fund, the employer’s contributions vary periodically, depending on actuarial advice, to ensure that there will be sufficient money in the fund to meet expected liabilities for benefits. In some cases, an employer may take a “contributions holiday” because contributions are not, at that time, needed to meet expected liabilities. Employer contributions to a defined benefit fund are not allocated to individual member accounts, but are held as an unallocated reserve. Members may, or may not, be required to contribute and members’ entitlements are determined by the provisions of the trust deed and rules. Accumulation funds An “accumulation fund” is a superannuation fund where the final benefit payable to a member is the amount accumulated in the member’s account at that time. The member’s account is credited with contributions made generally by the member or the member’s employer together with investment earnings. The account may be debited with fees, taxes and premiums for death or disablement insurance. Public sector funds A “public sector fund” is a superannuation fund that is part of a scheme for the payment of superannuation, retirement or death benefits, which is established: • under a Commonwealth, state or territory law, or • under the authority of the Commonwealth, state or territory government, a municipal corporation or a public authority constituted by or under a Commonwealth, state or territory law. A public sector fund may be unfunded, funded, or partly funded (such as the Commonwealth government superannuation fund for public servants). Constitutionally protected funds A “constitutionally protected fund” is a fund that is protected from tax liability by s 114 of the Constitution. Such a fund, eg one operated by a state government for its employees, cannot be liable to Commonwealth taxation as any imposition of tax would be a tax on the property of a state, which is prohibited by s 114. Funds that are constitutionally protected funds are prescribed in reg 995-1.04 and Sch 4 of the Income Tax Assessment Regulations 1997. Public offer superannuation funds A “public offer superannuation fund” is a superannuation fund regulated by APRA that offers or intends to offer superannuation interests to the public on a commercial basis, generally by issuing a Product Disclosure Statement. Such funds are offered by banks, life offices and investment companies. Industry funds are also generally operated as public offer funds. The trustee of a public offer fund must be a registrable superannuation entity (RSE) licensee (¶4-150) and must comply with rules relating to the issuing, offering or making of invitations of superannuation interests set out in SISA and in the Corporations Act 2001. Retail funds Retail funds are generally provided by financial institutions and insurance companies to cater for people who are interested in investing and saving for their retirement. Investment and administrative services are offered to clients. Retail funds are intended to generate revenue and profit for the provider. Industry funds Industry funds were developed by trade union and industry bodies to provide retirement income for their members. Although originally confined to workers within the relevant industry, industry funds have, in recent years, been opened to the general public and are now often public offer funds. Industry funds are

not-for-profit bodies and generally charge lower fees than other funds. Master funds or trusts Employer-sponsored funds or public offer superannuation funds may come under a master fund or trust arrangement that is offered by a finance institution. Such an arrangement groups a number of funds under a single master trust deed and provides professional administration for all the funds under the deed. Each fund has access to a wide range of investment, benefit design and insurance options according to its needs.

¶4-120 Other superannuation entities Retirement savings account providers Retirement savings accounts (RSAs) may be provided by banks, building societies, credit unions, life insurance companies and financial institutions approved by APRA as RSA institutions. RSAs are intended to be a simple, low-cost and low-risk savings product, which employers may use as an alternative to superannuation funds for their employees, and which individuals may use for personal superannuation contributions. RSAs are primarily intended for people with low amounts of superannuation benefits or with transient working patterns. RSAs take the form of a “capital guaranteed” account or policy offered by RSA providers. There is no limit to the amount that can be held in an RSA, but RSA providers must provide prescribed information to account holders when their account balance reaches $10,000. This includes information about the lowerrisk/lower-return nature of RSAs and about alternative products offering potentially higher returns over the longer term. RSAs are essentially invested in cash. They are convenient for investing small amounts; however, they are not suitable for long-term investment. Approved deposit fund (ADF) An ADF is an indefinitely continuing fund maintained by a corporate trustee approved by APRA, which receives, holds and invests certain types of roll-over funds until such funds are withdrawn. ADFs are principally roll-over vehicles. They cannot directly accept contributions or pay a pension and they must pay out a member’s benefits when the member reaches age 65 or dies. Pooled superannuation trust (PST) A PST is a unit trust maintained by a corporate trustee approved by APRA, which is used only for investing assets of regulated superannuation funds, ADFs, life offices and registered organisations. A PST pays tax at 15% and credits after-tax earnings to the superannuation funds which invest in it. Individual investors cannot invest in PSTs. Eligible roll-over fund (ERF) An ERF is a regulated superannuation fund or ADF which must treat all members as protected members and each member’s benefits as minimum benefits. These protection measures limit the expenses that a superannuation fund may deduct where a member’s account balance is less than $1,000. The account balance cannot be reduced by the deduction of expenses and, in effect, expenses cannot exceed investment earnings. Superannuation funds and ADFs which do not wish to comply with the member protection standards that apply to members with small account balances may transfer the benefit entitlements of affected members to ERFs.

¶4-150 Regulation of superannuation entities General administration of SISA and its regulations is primarily shared by the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investment Commission (ASIC) and the Commissioner of Taxation (ATO). As part of the superannuation regulatory regime:

• superannuation funds, other than SMSFs, are principally regulated by APRA, which is responsible for the prudential regulation of all deposit-taking institutions • SMSFs are regulated by the ATO • the ATO administers the early release of superannuation benefits on compassionate grounds • the Fair Work Ombudsman has general administration of employer notifications about superannuation contributions for employees • APRA and ASIC have joint responsibility for the regulation of RSA providers and RSA business, and • the ATO is responsible for the administration of the SG scheme. A superannuation fund must elect to be regulated (whether by APRA or the ATO) within 60 days of its establishment. A fund which elects to be a regulated fund will be entitled to concessional taxation treatment if it is a complying superannuation fund (¶4-320). To be a complying superannuation fund, a fund must have complied with the various requirements of SISA and SISR during the course of the year. These impose obligations on fund trustees relating to, for example, the sole purpose test, acceptance of contributions and payment of benefits, investment strategy and licensing rules. If a fund does not comply, it may lose its concessional tax status and penalties may be imposed on those who are responsible for the non-compliance, eg the trustees. Licensing and registration requirements Superannuation entities that are registrable superannuation entities (RSEs) must hold an RSE licence and must register with APRA. A “registrable superannuation entity” means a regulated superannuation fund, an ADF or a PST (but not an SMSF). To obtain an RSE licence and to register a fund, the trustees must have a risk management plan for the fund that sets out reasonable procedures that the RSE licensee will apply to identify, monitor and manage risks that arise in operating the entity. The RSE licence is in addition to the Australian Financial Services Licence (AFSL) issued by ASIC to providers of financial services under the Corporations Act. Holding an AFSL licence is a requirement for undertaking certain types of business activities under an RSE licence, eg where the trustee is dealing in a financial product or providing advice about financial products. Resolution of complaints about superannuation matters ASIC is responsible for the administration of the resolution of complaints scheme. Disputes regarding superannuation, including those relating to the conduct and decisions of superannuation fund trustees, are dealt with by the Australian Financial Complaints Authority (AFCA). Before 1 November 2018, superannuation complaints were dealt with by the Superannuation Complaints Tribunal (SCT). AFCA deals with all financial system complaints, replacing the SCT, Financial Ombudsman Service and the Credit and Investments Ombudsman (¶8-615). The SCT will continue operations until 1 July 2020 to resolve the current backlog of complaints. Levies Superannuation entities are required to pay a supervisory levy to the ATO in the case of SMSFs or to APRA in the case of other superannuation entities. The supervisory levies are tax deductible. Funds that are regulated by APRA are also liable to pay a levy to provide financial assistance where the fund or its beneficiaries suffer loss from fraudulent conduct or theft. The levy does not apply to SMSFs. The financial assistance levy is deductible and a grant of financial assistance is exempt from income tax.

¶4-160 Superannuation and bankruptcy laws Generally, the interest of a member in benefits in a superannuation fund is protected from creditors in the event of the member’s bankruptcy. The protection is subject to provisions in the Bankruptcy Act 1966, which allow bankruptcy trustees to recover any superannuation contributions made prior to bankruptcy with the intention of defeating creditors. Superannuation contributions made before bankruptcy The bankruptcy trustee may recover the value of contributions made by the bankrupt member, or by another person for the benefit of the bankrupt member, if the purpose of the contributions was to defeat creditors. Any consideration given by the superannuation trustee for the contribution will be ignored in determining whether the contribution is recoverable by the bankruptcy trustee. This overcomes the 2003 High Court decision in Cook v Benson that cast doubt on a bankruptcy trustee’s power to recover contributions where a trustee had provided consideration for the contributions. The pattern of a bankrupt’s past contributions and whether any contributions are uncharacteristic will be considered by a court in determining whether they are made to defeat creditors. The Official Receiver has power to issue a notice to the fund to freeze the contributions to prevent the bankrupt from rolling them into another fund or otherwise dealing with them in a way that would prevent recovery by the bankruptcy trustee. The overall effect is that contributions to superannuation funds to defeat creditors may be recoverable in the same way as other payments or transfers to defeat creditors.

CONTRIBUTIONS TO SUPERANNUATION FUNDS ¶4-200 Superannuation contributions Tax concessions may be available to people who make superannuation contributions. The contributions may be made by employers on behalf of employees (sometimes after the employee enters into a salary sacrifice arrangement) or by members on their own behalf or on behalf of someone else, such as their spouse. The concession may be a tax deduction, a government co-contribution, a low income superannuation tax offset or a tax offset for spouse contributions. A contribution is essentially anything of value that increases the capital of a fund and that is provided for the purpose of providing superannuation benefits. The meaning of “contributions” and when they are made is discussed at ¶4-203. Fund must be able to accept the contributions Contributions can only be made for a person (whether by an employer, a member or another person) if the fund is allowed to accept the contributions. The rules on when a fund can accept contributions are discussed at ¶4-205. Importance of quoting a tax file number It is important that a member’s tax file number is quoted to the superannuation fund when a contribution is made, because otherwise the following adverse consequences may arise: • the fund could not accept personal contributions (¶4-220) from the member or, if it accepted the contributions, would have to return them to the member • a government co-contribution (¶4-265) or low income superannuation tax offset (¶4-270) would not be payable for the member, and • additional tax might be payable by the fund on the contributions (¶4-390). Concessional contributions

Contributions are classified as either “concessional” or “non-concessional” contributions. Concessional contributions are contributions made by an employer for a member or by a member personally, where a deduction has been allowed and the contributions are included in the assessable income of a superannuation fund. Concessional contributions are generally taxed at 15%, although concessional contributions for high-income individuals may be taxed at 30% (¶4-225). A deduction is allowed for contributions made by employers on behalf of their employees provided certain conditions are met (¶4-210). A deduction is also allowed for personal contributions made by members if certain conditions are met (¶4220). If a deduction is not allowed for a personal contribution, a government co-contribution (¶4-265) or low income superannuation tax offset (¶4-270) may be allowed. Even though employer or member contributions may be deductible, there are limits on the amount of concessional contributions that can benefit from concessional treatment (eg being taxed at 15% when paid to the fund). If the concessional contributions made for a member in a year exceed the member’s concessional contributions cap for the year ($25,000 for 2020/21), the excess amount is included in their assessable income and taxed at marginal rates. An individual may elect to have 85% of their excess concessional contributions for a year released from superannuation. The individual is also liable to excess concessional contributions charge. The treatment of excess concessional contributions is discussed at ¶4-234 and ¶4-235. Non-concessional contributions Non-concessional contributions are generally contributions made by a member where a deduction has not been allowed and the amount is not included in the assessable income of the fund. Non-concessional contributions are taxed at 0% when paid into the fund and at 0% when paid from the fund as a superannuation benefit. If a member has non-concessional contributions in excess of their non-concessional contributions cap ($100,000 for 2020/21), the member may elect to withdraw excess contributions plus 85% of the associated earnings on the contributions. No tax is imposed on the excess contributions that are withdrawn, but all of the associated earnings are included in the member’s assessable income and taxed at ordinary rates (¶4-245). The member may be liable to excess non-concessional contributions tax on any excess amount that is not withdrawn from the fund. The treatment of excess non-concessional contributions is discussed at ¶4-240 and ¶4-245. Commissioner may disregard or reallocate contributions In limited circumstances, liability to penalties on excess contributions can be avoided if the Commissioner makes a determination that certain contributions should be disregarded or reallocated to another year (¶4250). The Commissioner can only make such a determination if there are special circumstances and the making of the determination would be consistent with the objects of the legislation. Issues relating to contributions The following matters affecting contributions to superannuation funds are of relevance to financial planning: • the meaning of “contributions” and when they are made (¶4-203) • when contributions can be accepted (¶4-205) • deductions for employer contributions (¶4-210) • the consequences of sacrificing salary into superannuation (¶4-215) • the deductibility of personal contributions (¶4-220) • the use of superannuation contributions by first home buyers (¶4-222) • contributions made by people aged 65 and over from the proceeds of selling their home (¶4-223)

• the imposition of Division 293 tax on the concessional contributions of high-income earners (¶4-225) • the transfer balance cap rules that limit the amount of capital a member can transfer to the retirement phase to support a superannuation income stream (¶4-227 to ¶4-232) • a member’s total superannuation balance (¶4-233) • the treatment of a member’s excess concessional contributions or excess non-concessional contributions (¶4-234 to ¶4-245) • whether excess contributions may be disregarded or reallocated to another year (¶4-250) • the splitting of a member’s contributions with the member’s spouse (¶4-260) • a low income member’s entitlement to a government co-contribution to match their personal contributions (¶4-265) • entitlement to a low income superannuation tax offset to compensate for the 15% tax imposed on deductible contributions (¶4-270) • eligibility for a tax offset for contributions made for a spouse (¶4-275), and • how contributions are taxed in the fund (¶4-280).

¶4-203 Contributions made to a fund When “contributions” are made to a fund, there may be tax consequences for the contributor, for the member for whom the contributions are made and for the fund itself.

The ATO’s view is that a contribution to a fund is anything of value that both: • increases the capital of the fund, and • is provided by a person with the intention of providing superannuation benefits for one or more members of the fund (Taxation Ruling TR 2010/1). A contribution would usually be money, but it can also be the transfer of an asset such as business property (an in specie contribution), in which case the amount of the contribution is the market value of the asset. A contribution can also be an addition to the value of an existing asset by, for example, making an improvement, or when a creditor forgives a debt owed by the fund. The roll-over of a member’s superannuation interest from one fund to another and the transfer of a benefit from an overseas fund to an Australian superannuation fund would be contributions as they both increase the capital of the receiving fund.

A contribution may also be made: • when an employer pays expenses on behalf of a fund • when an employer makes contributions after an employee enters into a salary sacrifice arrangement, and • subject to conditions being satisfied, when money is transferred, at the employer’s direction, from an accumulation fund’s reserve account or surplus to a member’s account in the fund. The timing of a contribution The time an employer contribution is made is important because the employer can only deduct a contribution for the income year the contribution is “made” by the employer. The timing of a contribution also determines the year in which other tax concessions are allowed and whether there are excess contributions (¶4-234) for a member for the year. Timing of a contribution for deduction purposes For deduction purposes, a contribution is generally “made” to a fund when it is received by the fund. A contribution by electronic funds transfer is made when the amount is credited to the fund’s bank account, and an in specie contribution is made when ownership in the property passes (Taxation Ruling TR 2010/1). This rule also generally applies if an employer contributes to the Small Business Superannuation Clearing House, rather than directly to an employee’s superannuation fund, and the clearing house later pays the contribution to the employee’s fund. The application of this rule would mean a contribution for an employee to the clearing house would not be deductible until it is received by the employee’s fund. Only employers who have fewer than 20 employees or who have an annual aggregated turnover of no more than $10m are permitted to use the clearing house to make SG contributions (¶4-500). The ATO’s view, however, is that there may be an exception to the general rule. The ATO states in Practical Compliance Guideline PCG 2020/6 that an employer can deduct contributions to the clearing house in the year the contributions are made to the clearing house if the following conditions are met: • the employer makes the contributions before the close of business on the last business day of the income year, ie on or before 30 June • when making the contributions, the employer provides all relevant information to enable the clearing house to make the payment to the employees’ superannuation fund accounts • the payment is not dishonoured by the superannuation fund or returned to the employer by the clearing house, and • the employer would otherwise be entitled to the tax deduction because they meet the relevant deduction requirements (¶4-210). If these conditions are not satisfied, the employer’s contributions to the clearing house would be treated as being made when they are received by the fund, and it would only be in that year that a deduction would be allowed. Timing of a contribution for SG purposes For the purpose of determining if an employer has satisfied its SG obligations (¶4-500), a payment to the clearing house is treated as an employer contribution to the employee’s fund when it is made to the clearing house (SGAA s 23B).

¶4-205 Acceptance of contributions A superannuation fund can only accept contributions for a member in the circumstances set out in the Superannuation Industry (Supervision) Regulations 1994 (SISR).

Mandated employer contributions A superannuation fund may accept “mandated employer contributions” in respect of a person without restrictions, ie regardless of the person’s age or the number of hours that the person works. Mandated employer contributions may be any of the following contributions that an employer is required to make: • SG contributions made on behalf of an employee for whom the employer is required to contribute and where the contributions reduce the employer’s potential liability for the SG charge (¶4-500) • SG shortfall components, ie payments that an employer must make when their SG contributions fall short of what is required (¶4-560) • award contributions made in satisfaction of the employer’s obligations under an industrial agreement or award, or • payments to an individual’s account in a superannuation fund from the Superannuation Holding Accounts Special Account (SHASA) (SISR reg 5.01(1) and (2)). Employers are generally required to make SG contributions regardless of the age of the employee for whom the contributions are made (¶4-520). There is no maximum age for the making of SG contributions. SG contributions do not need to be made for an employee who is aged under 18 and is working only parttime, so employer contributions for such an employee would not be mandated employer contributions unless an award requires the employer to contribute. An award or other industrial law may require an employer to make contributions for employees in circumstances where SG contributions would not be required, eg if the employee is aged under 18 and working part-time. Where members have an effective arrangement with their employer to sacrifice salary to superannuation, the contributions are treated as employer contributions (¶4-215). However, only contributions up to the required SG level (9.5% of an employee’s ordinary time earnings base for 2020/21 — see ¶4-540) or the industrial law level (if higher than 9.5%) are mandated employer contributions. Acceptance of other contributions Apart from mandated employer contributions, the general rule from 1 July 2020 is that a fund may accept contributions as follows (SISR reg 7.04). • A person under age 67 can make personal contributions without restrictions. • A person who has reached age 67 but not 75 can contribute if they satisfy the “work test” (see below). • Personal contributions cannot be made by a person who has reached age 75. Before 1 July 2020: • only a person under 65 could make personal contributions without restrictions • a person aged over 65 and under 75 was required to satisfy the work test to be able to make personal contributions, and • a person who had reached 75 could not make personal contributions. From 1 July 2020, contributions can be accepted for a spouse who is aged under 75. Contributions for a spouse aged between 67 and 75 can only be accepted if the spouse satisfies the work test during the year or is eligible for the one-year work test exemption (see below). Before 1 July 2020, a fund could only accept contributions for a spouse aged under 70. Work test — gainfully employed on a part-time basis A person satisfies the work test if they are “gainfully employed”, ie they are employed or self-employed for

“gain or reward” in any business, trade, profession, vocation, calling, occupation or employment (SISR reg 1.03(1)). The APRA view is that “gain or reward” involves remuneration such as salary or wages, business income, bonuses, commissions, fees or gratuities, in return for personal exertion. This would not generally include income that comes only from passive investments such as dividends, interest and capital gains. Example Ming turned 69 on 13 May 2020 and retired from employment on 30 June 2020. After her retirement, she continued to receive income from her investments and dividends from her shareholdings and also volunteered at the local community centre 12 hours a week. Ming is not entitled to make contributions for the 2020/21 tax year because she is not gainfully employed.

A person is gainfully employed “on a part-time basis” during an income year if the person has worked at least 40 hours in a period of not more than 30 consecutive days in that financial year. Example Sandra, aged 68, works full-time from 1 July 2020 to 15 July 2020. She then retires and does not perform any paid work during the remainder of the 2020/21 income year. Although she works only for the first two weeks of the 2020/21 tax year, Sandra is gainfully employed on a part-time basis during 2020/21 and a fund may accept contributions from her.

Work test exemptions From 1 July 2019, individuals who would otherwise be required to satisfy the work test (ie individuals who have reached age 65 before 1 July 2020 and individuals who have reached age 67 from 1 July 2020) may be able to make personal contributions for 12 months from the end of the financial year in which they last met the work test. To be eligible for the one-year exemption, a member’s total superannuation balance (¶4-233) must be less than $300,000 at the end of the previous financial year but is not required to remain at less than $300,000 during the year the contribution is made. The member must have met the work test in the previous financial year and must not previously have made use of the work test exemption. Contributions by a person aged 65 and over from the proceeds of selling their home A fund may accept contributions from a person aged 65 and over where the contributions come from the sale of the person’s home (¶4-223). This is an exception to the general rules that apply when an individual has reached 65. Summary of contribution rules The following table summarises the general circumstances (subject to the exceptions noted above) under which a fund can accept contributions for the 2020/21 income year: Member under 65 years

– a fund can accept all contributions made for a person who is under 65 years of age, irrespective of employment or other income earning status.

Member 65 to under 70

– a fund can accept all contributions (personal, employer, spouse) if the person for whom the contribution is made has been gainfully employed for at least 40 hours in a period of not more than 30 consecutive days in that financial year (work test). – a fund can accept mandated employer contributions.

Member 70 to under 75

– a fund can accept personal contributions or non-mandated employer contributions for a member if the member has been gainfully employed for at least 40 hours in a period of not more than 30 consecutive days in that financial year (work test) and the contributions are received on or before 28 days after the end of the month in which the member turns 75. – a fund can accept mandated employer contributions.

Member 75 or over

– a fund can only accept mandated employer contributions.

Member contributions may not be accepted in certain cases A regulated superannuation fund may not accept personal contributions where the member’s TFN has not been quoted to the fund. The TFN may be quoted to the fund by the member or by the member’s employer, or may be given to the fund by the ATO. A fund that accepts member contributions in breach of this rule must return the contributions, generally within 30 days of becoming aware of the breach. Before 1 July 2017, a fund could not accept a “fund-capped contribution” (broadly, a non-concessional contribution made by a member) in an income year that exceeded their non-concessional contributions cap for the year. This rule was intended to prevent members inadvertently breaching the nonconcessional contributions cap rules. A fund that accepted a contribution in excess of a member’s allowable amount was required to return the excess amount. The fund-capped contribution limit was replaced from 1 July 2017 by eligibility conditions based on a member’s total superannuation balance (¶4-233). Amounts transferred from KiwiSaver schemes A fund may be able to accept the transfer of a member’s superannuation from a New Zealand KiwiSaver scheme (¶4-440). The transferred amount is treated as a non-deductible personal contribution. Accrual of benefits — defined benefit funds The general rules for making contributions cannot apply to defined benefit funds as contributions are not specifically allocated to individual members. For these funds, rules apply to the accrual of benefits rather than the acceptance of contributions.

¶4-210 Employer superannuation contributions An employer is allowed a tax deduction for all contributions paid to a superannuation fund as long as a number of conditions are satisfied. Although the amount of the employer’s deduction is generally not limited, the employee may be penalised if contributions by the employer on behalf of the employee exceed the concessional contributions cap (¶4-234). An employer contribution is taxed at 15% when it is paid to a complying superannuation fund (¶4-280). Concessional contributions made for high-income taxpayers may be subject to an additional 15% Division 293 tax (¶4-225). This affects both employer and personal contributions for which a deduction has been claimed. To compensate for the imposition of the 15% contributions tax, a low income superannuation tax offset may be payable for a low income earner (¶4-270). Conditions to be satisfied for a contribution to be deductible For an employer contribution to be deductible, the following conditions must be satisfied (s 290-80 of the Income Tax Assessment Act 1997 (ITAA97)). (1) Contribution is for the purpose of providing superannuation benefits for an employee of the employer To be entitled to a deduction, an employer must make a contribution “for the purpose” of providing superannuation benefits for an employee. The Commissioner considers that this must be the contributor’s sole purpose (Taxation Ruling TR 2010/1). A deduction would not be allowed if contributions were specifically intended to provide superannuation benefits for a dependant of an employee, although a dependant may benefit if an employee dies. “Superannuation benefits” means “individual personal benefits, pensions or retiring allowances” (ITAA36 s 6(1)). A contribution will be made for the purpose of providing superannuation benefits for an employee if it is intended to benefit a particular employee who is a member of the fund or an identifiable class of employee. The employer is not required to formally allocate the contribution to a particular employee, but an employee for whom a contribution is made must have fully secured rights to the superannuation benefit.

The contribution must be made to provide superannuation benefits for a person who is an “employee” of the employer when the contribution is made, even if the benefits are payable to a dependant of the employee because of the employee’s death. “Employee” means: • an employee within the ordinary meaning, generally a person who is paid wages or salary in return for their services, or • a person who is deemed to be an employee for the purposes of the SG rules (¶4-520). This would most commonly be a person who works under a contract that is wholly or principally for the person’s labour. In the case of persons who are only employees because of the expanded SG definition, employer contributions may be deductible even if the employer is not required to contribute on their behalf but does so voluntarily. SG contributions are not, for example, required to be made for employees aged under 18 and working part-time, but if an employer chooses to make such contributions, the contributions may be deductible. In France 2010 ATC ¶10-158, the Administrative Appeals Tribunal found that there was not an employment relationship between a husband and a wife who owned an investment property and that contributions made by the husband on behalf of the wife were not deductible as they were made under a merely domestic arrangement. In certain cases a contribution for a former employee may be deductible, eg if the contribution reduces the employer’s SG charge percentage for the employee. Example Milo’s employment with Argus is terminated on 30 September 2020. The SG liability of Argus in respect of Milo for the September 2020 quarter is $2,500. To avoid incurring liability to SG charge, Argus is required to contribute this amount to a complying superannuation fund by 28 October 2020. If Argus makes this contribution, it will be deductible, even though Milo is at this time a former employee.

(2) Employment activity condition An employer is only entitled to a tax deduction if the individual for whom the contributions are made satisfies the employment activity condition. This means the individual must be: • an employee within the expanded meaning for SG purposes (¶4-520), or • engaged in producing the assessable income of the employer, or • an Australian resident who is engaged in the employer’s business. Directors satisfy the employment activity condition if they are “entitled to payment” for the work they do for the company. A director is generally only treated as entitled to payment if the entitlement is specifically provided for in the company’s constitution or approved by resolution of the shareholders. In Kelly v FC of T (No 2) 2012 ATC ¶20-329 (upheld by the Full Federal Court in Kelly 2013 ATC ¶20-408), a director was found not entitled to payment, and not therefore deemed to be an employee for whom the company was entitled to deductions for superannuation contributions. Although the director was paid a superannuation benefit by the company, there was no evidence of a company resolution giving him the entitlement to the payment. The fact of payment did not, by itself, prove the entitlement. Contributions for a director of a company that derives its assessable income from passive investments such as shares and bonds may be deductible as long as the director is entitled to payment for their services (ATO ID 2007/144). Example Melissa is a director of a company that derives its income from passive investments. As a director, Melissa is an employee for SG

purposes (SGAA s 12(2)) and satisfies the employment activity condition as long as she is entitled to payment for the performance of her duties as a director.

(3) Contribution to a complying superannuation fund For the contribution to be deductible, one of the following conditions must apply: (a) the fund receiving the contribution is a complying superannuation fund (¶4-310) (b) it is reasonable for the employer to believe the fund is a complying fund, or (c) the employer has obtained a written statement that the fund is a resident regulated superannuation fund that can accept employer contributions. (4) Age conditions To be deductible, an employer contribution for an employee must come within at least one of the following three situations: (a) the contribution is made no later than the 28th day after the end of the month in which the employee turns 75 (b) the employer is required to make the contribution by an industrial award, agreement or law, or (c) the contribution counts as an SG contribution for the employee. Since 1 July 2013, there has not been a maximum age limit for SG contributions and employers may be able to claim deductions for such contributions for employees regardless of their age. In earlier years, the SG scheme only required an employer to make contributions for an employee until the employee reached 70 years. Although there is no longer a maximum age limit for SG contributions, an employee’s age may affect the amount of an employer’s deduction: • if the contribution is made by the 28th day after the end of the month in which the employee turns 75, all of the contribution may be deductible • if the employee is older than 75 and the contribution is only counted for SG purposes, the employer can deduct only the minimum amount required for SG purposes, that is, 9.5% of the employee’s ordinary time earnings base for 2020/21 (¶4-540), and • if the employee is older than 75 and the employer is required to make the contribution by an industrial award and also under SG law, the employer can deduct only the greater of the amount that is required to be contributed by the industrial award and the amount that is required to be contributed under SG law. A voluntary contribution by an employer for an employee who is aged at least 75 would not be deductible if it is made later than 28 days after the end of the month in which the employee turned 75. Example During 2020/21, an employer contributes $2,000 to a superannuation fund on behalf of an employee who is aged 76. Because the employee works as a casual store man and is only paid $420 per month, the employer is not liable to make SG contributions on his behalf (¶4-520). Neither is the employer required by an industrial law to make the contributions. As the employer’s contributions are voluntary contributions, not covered by either SG or industrial law requirements, and the employee is aged over 75, the contributions are not deductible. If the employee earned at least $450 in any month, the employer would be required to make SG contributions for that month and they would be deductible.

Salary sacrifice contributions

Salary sacrifice contributions to a complying superannuation fund are treated as employer contributions. Salary sacrifice arrangements and their consequences for employees and employers are discussed at ¶4215. Employer contribution to a non-complying superannuation fund An employer contribution for an employee to a non-complying superannuation fund that the employer does not reasonably believe to be a complying fund is not deductible and is subject to fringe benefits tax. An employer is also liable to fringe benefits tax where a contribution is made for a person who is not an employee of the employer, eg a spouse. Splitting contributions with a spouse Contributions made by an employer on behalf of an employee may generally be split with the employee’s spouse. The contributions splitting rules are discussed at ¶4-260.

¶4-215 Employer contributions following salary sacrifice Salary sacrifice involves an employee entering into an agreement with their employer for some of their salary to be sacrificed in return for fringe benefits or increased employer superannuation contributions. Consequences for an employee Salary sacrifice is attractive if it results in a lower income tax liability for an employee. This would be the case if the benefits received by the employee are taxed at a lower rate than the income would have been if it had not been sacrificed. Although the FBT rate is generally the same as the highest individual income tax rate plus Medicare levy (47% for the FBT year from 1 April 2020 to 31 March 2021), many fringe benefits such as child care or cars may be taxed at a lower rate or be exempt from FBT. Employer contributions for an employee to a complying superannuation fund are not a fringe benefit, and therefore there may be tax savings if salary is sacrificed into superannuation. These tax savings can only be achieved if salary is sacrificed under an “effective” salary sacrifice arrangement. This involves an employee giving up a future entitlement to salary, rather than salary that has already been earned (Taxation Ruling TR 2001/10). Reportable employer superannuation contributions The attraction of sacrificing salary for employer superannuation contributions is reduced for some employees because “reportable employer superannuation contributions” (RESCs), which include salary sacrifice contributions, are taken into account in determining if an individual: • is eligible for a government co-contribution when they make contributions (¶4-265) • is eligible for a low income superannuation tax offset (¶4-270) • is entitled to a tax offset when they make contributions for a spouse (¶4-275) • has exceeded their concessional contributions cap for the year (¶4-234), or • is liable to pay an additional 15% Division 293 tax on their concessional contributions (¶4-225). An individual’s RESCs may also be counted in the income tests for eligibility for dependant tax offsets, liability to Medicare levy surcharge and repayments of higher education loan program (HELP) debts, entitlement to certain Centrelink benefits, and obligations to make child support payments. For years before 2017/18, RESCs were also taken into account in determining if an individual was entitled to a deduction for their personal superannuation contributions (¶4-220). RESCs are contributions made by an employer (or an associate of the employer) for an employee to the extent that the employee could influence the size or the manner of the contribution (s 16-182 in Sch 1 of the Taxation Administration Act 1953 (TAA)). This will most commonly catch employer contributions resulting from a salary sacrifice arrangement. It is

not intended to catch contributions that an employer is already obliged to make, eg SG contributions by an employer or contributions under an industrial agreement (unless the employee can influence the terms of the agreement). If the employee is an associate of the employer (eg related by family), there is a rebuttable presumption that the employee had the capacity to influence the contribution amount. An RESC does not include additional superannuation contributions for an employee as a result of some action by the employee if the contributions are required by an “industrial instrument” or rules of a superannuation fund and the employee has no capacity and cannot reasonably be expected to have the capacity to influence the content of that requirement. An “industrial instrument” means an Australian law or an award, order, determination or industrial agreement in force under an Australian law and includes a modern award or enterprise agreement (as defined in the Fair Work Act 2009). Example Ralph’s employer is required to make an employer contribution for him under the deed of the superannuation fund to which Ralph’s employer contributes. This deed is subordinate legislation under a state law. The contribution amount prescribed in the deed is based on Ralph’s personal contribution — if, for example, Ralph contributes 0%, 5% or 8%, his employer must contribute 9%, 11.5% or 13% respectively. If Ralph contributes 8% of his salary as a personal after-tax contribution and, as required under the deed, his employer contributes 13%, none of the amount the employer contributes is an RESC as the additional employer contributions are required by an Australian law. Neither Ralph nor his employer has capacity to influence the requirement for the additional contribution to be made or its size as the contribution and its amount are determined by the deed. Ralph’s personal contributions are also not RESCs as they are made from his assessable income.

Examples of RESCs include: • additional employer contributions made under an employment contract whose terms and conditions the employee has influenced, or additional employer contributions made for an employee as part of a negotiated remuneration package, and • employer contributions that the employee has influenced to be made in such a way that the employee’s assessable income is reduced, even if the requirement to make the contribution, or the contribution size, is prescribed by an industrial instrument or by fund rules. If an employer makes additional superannuation contributions to cover the cost of premiums for insurance cover for an employee due to the choice of superannuation fund made by the employee (¶4-580), the additional contributions are RESCs (ATO ID 2010/112). Consequences for an employer The consequences for an employer of an effective salary sacrifice into superannuation include that the employer may be entitled to a deduction for the contributions (¶4-210). From 1 January 2020, salary sacrifice contributions do not count in calculating whether an employer has complied with their SG obligations and cannot reduce the earnings base upon which SG obligations are calculated (¶4-540). Previously, salary sacrifice contributions could be counted by an employer in determining compliance with their SG obligations and could reduce the earnings base upon which SG obligations were calculated.

¶4-220 Personal superannuation contributions Individuals who make superannuation contributions in order to obtain superannuation benefits for themselves, or for their dependants in the event of their own death, may be entitled to tax concessions for those contributions as follows: • a deduction — if the deduction conditions are satisfied • a government co-contribution — individual contributors who receive income from employment or business may be entitled to a government co-contribution if their income is low and they have not received a deduction for the contributions (¶4-265)

• a low income superannuation tax offset — a low income earner for whom deductible contributions are made may be entitled to a low income superannuation tax offset to compensate them for the 15% tax imposed on the contributions (¶4-270), and • a tax offset for spouse contributions — contributions on behalf of a low income spouse may entitle the contributor to a tax offset (¶4-275). A member can only make personal contributions to a superannuation fund if the fund is allowed to accept contributions from that member. As explained at ¶4-205, this depends on the member’s age, whether the member satisfies the work test (if required) and whether the member provides their tax file number. Deduction for personal contributions If the deduction conditions are satisfied when a member makes a personal contribution and the member claims a deduction, the member’s contribution is a concessional contribution. If the member does not claim a deduction, the contribution is a non-concessional contribution. Although there is generally not a specific limit on the amount of concessional contributions that may be made by a member for a year or on the deduction allowable, tax consequences arise for a member if their concessional contributions for a year exceed their concessional contributions cap for the year. These tax consequences may indirectly create a limit. The concessional contributions cap is $25,000 for 20120/21, the same as for the previous three years. The consequences that arise for a member with excess concessional contributions (¶4-234 and ¶4-235) are intended to discourage the making of contributions in excess of the contributions cap. As with employer contributions, deducted personal contributions are generally taxed at 15% when paid to the fund. Concessional contributions made by or for high-income earners may also be liable to an additional 15% Division 293 tax (¶4-225). Conditions to be satisfied for a contribution to be deductible Personal contributions by a member are deductible for 2020/21 (and the previous three years) if the following conditions are satisfied (ITAA97 s 290-150 to 290-180). 1. The contribution is made for the purpose of providing superannuation benefits for the member, although the benefits may ultimately be paid to dependants if the member dies. 2. If the contribution is to a superannuation fund, it is a complying superannuation fund. Personal contributions to the following superannuation funds are not deductible: (a) contributions to Commonwealth public sector superannuation schemes by members with defined benefit interests (b) untaxed funds that do not include an amount in their assessable income as a result of receiving superannuation contributions, and (c) certain funds that are prescribed in the regulations and in which a member holds a defined benefit interest — the fund may choose for either all contributions to the fund, or contributions to defined benefit interests in the fund, to be non-deductible. 3. Age-related conditions require: (i) a contributor aged under 18 at the end of the income year to have earned income from carrying on a business or from employment during the year, and (ii) in any other case, a contribution to be made by the 28th day after the month in which a contributor turns 75. 4. The contribution must not be a downsizer contribution made from the proceeds of the sale of the main residence owned by the contributor for at least 10 years (¶4-223). 5. The contributor must notify the trustee in writing that they intend to claim the deduction and they receive acknowledgment of the notice from the trustee (see “Notice requirements” below). Even if these conditions are satisfied, a member’s deduction for a contribution may be limited in other

ways. These include: • a deduction cannot create or increase a loss for the year and so is limited to the amount that reduces the member’s taxable income to zero (ITAA97 s 26-55) • a contribution is not deductible to the extent that it is attributable to a capital gain from the disposal of small business assets where a member who is aged under 55 years elects for an amount up to $500,000 to be disregarded for CGT purposes and to be used for retirement (ITAA97 s 152-305) — in that case, only the amount of the contribution that exceeds the $500,000 exempt amount could be deductible • a contribution for a member who is a partner in a partnership cannot be taken into account in calculating the net income or loss of the partnership (ITAA36 s 90), and • a member who borrows money to make a contribution is not entitled to a deduction for interest on the loan (ITAA97 s 26-80). Notice requirements A deduction for personal superannuation contributions is only allowable if: • the member has given a notice to the trustee of the fund stating the intention to claim a deduction for all or part of the contribution covered by the notice, and • the member receives an acknowledgment of the notice. A notice of an intended deduction claim cannot be given to a superannuation fund if: • the person has ceased to be a member of the fund (eg the member has rolled all their benefits into another fund) • the trustee no longer holds the relevant contributions, or • the trustee has begun to pay a superannuation income stream based in whole or part on the contributions. In any case, the notice must be given by the earlier of: (i) the day the person lodges their income tax return for the year the contribution is made, and (ii) the end of the next income year. Once made, a notice cannot be revoked or withdrawn, but it can be varied to reduce (including to nil) the amount the member wishes to deduct. A variation is only effective if the person is still a member of the fund, the trustee still holds the contribution and the trustee has not commenced to pay a superannuation income stream based on the contribution. A notice generally cannot be varied after the earlier of: (i) the day the person lodges their income tax return for the year in which the contribution is made, and (ii) the end of the financial year following the year the contribution is made. Pre-2017/18 deduction condition — the 10% rule For years before 2017/18, the “10% rule” was important in determining eligibility for a deduction for member contributions. The rule had the effect that it was only in rare cases that an employee could claim a deduction for personal contributions, and a deduction was generally restricted to the self-employed and the substantially self-employed. Under the 10% rule, a member’s contribution was only deductible if less than 10% of the total of the following amounts came from employment-related activities in the year:

• the member’s assessable income — this could include salary, termination payments, superannuation benefits, net capital gains, dividends, interest or rent • the member’s reportable fringe benefits total — these are fringe benefits that are reported on an employee’s payment summary because the employer has provided the employee with fringe benefits with a taxable value exceeding $2,000 in a year (see ¶3-155), and • the member’s RESCs — basically contributions made by an employer for an employee where the employee could influence the size or the manner of the contribution (¶4-215). Employer contributions for an employee after the employee entered into a salary sacrifice arrangement (¶4-215) were counted as income in determining if the employee was entitled to a deduction. Excess concessional contributions (¶4-234) were not included. “Employment-related activities” means activities which result in the individual being treated as an employee for SG purposes. This includes not only employees within the ordinary meaning but also individuals who are deemed to be employees for SG purposes, eg persons who work under a contract that is principally for their labour (¶4-520). Example In the 2016/17 year, Stefan earned $85,000 from his landscape gardening business. He also earned $18,000 from teaching at TAFE and had a reportable fringe benefits total of $3,925. TAFE withheld PAYG amounts from Stefan’s earnings and made $1,500 SG contributions, but no other contributions, for him. The total of Stefan’s assessable income, reportable fringe benefits total and RESCs for 2016/17 was $106,925, of which 20.5% (ie the $18,000 + $3,925 relating to his work for the TAFE) was derived from employment-related activities. The $1,500 SG contributions were not taken into account as they were not RESCs. Because the proportion of the total of Stefan’s assessable income, reportable fringe benefits total and RESCs that came from employment-related activities was more than 10%, he failed the 10% rule and was not entitled to a deduction for contributions he made in 2016/17.

Employment income of an Australian resident employed overseas by a foreign employer could be counted in the 10% rule (Taxation Ruling TR 2010/1). For a foreign resident, income from employment outside Australia was not assessable in Australia and so was not counted.

¶4-222 First Home Super Saver scheme Under the First Home Super Saver (FHSS) scheme, individuals can contribute up to $30,000 into superannuation and withdraw the contributions to use as a deposit on a first home. The withdrawn contributions and deemed earnings on the contributions are taxed at the contributor’s marginal tax rates less a 30% offset. Contributions have been able to be made into superannuation for this purpose on or after 1 July 2017 and to be withdrawn on or after 1 July 2018. Allowing contributions to be withdrawn and used to acquire a first home is an exception to the general rule that contributions must be made for the purpose of providing superannuation benefits (¶4-220). Eligible individuals To be eligible to participate in the FHSS scheme, an individual must: (i) be aged at least 18 years (ii) have not previously owned a home or, if they have previously owned a home, the Commissioner determines they are allowed to participate because of financial hardship they have suffered, and (iii) have not previously requested the release of superannuation contributions under the FHSS scheme. Eligible contributions

Contributions are eligible for the purposes of the FHSS scheme if they were made: (i) as voluntary employer contributions such as salary sacrifice contributions (but not compulsory employer contributions) or voluntary personal contributions, and (ii) as concessional contributions within the concessional contributions cap for the year ($25,000 for 2020/21 and the previous three years) or as non-concessional contributions within the nonconcessional contributions cap for the year ($100,000 for 2020/21 and the previous three years). Up to $15,000 of contributions can be eligible for one financial year and total FHSS contributions cannot exceed $30,000. Withdrawn contributions On or after 1 July 2018, individuals can apply to withdraw up to their “FHSS maximum release amount”, which is the total of: (i) the sum of their FHSS non-concessional contributions and 85% of their FHSS concessional contributions, and (ii) associated earnings on the FHSS releasable contributions calculated on a compounding daily basis based on the shortfall interest charge rate. Concessional contributions and associated earnings that are withdrawn are included in the contributor’s assessable income and taxed at marginal rates with the benefit of a non-refundable offset equal to 30% of the assessable amount. For released amounts of non-concessional contributions, only the associated earnings are taxed, with a 30% tax offset. An individual is not required to wait until they receive their released amount before entering into a contract to purchase or construct premises, but once a contract has been entered into they have a maximum of 14 days to apply for the release of their money. The purchase or construction contract can be entered into in the period beginning 14 days before and ending 12 months after they made the withdrawal request. The premises must be occupied by the individual as soon as practicable after it is purchased or constructed and for at least six months of the first year. An individual who does not enter into a contract within the required period to purchase or construct a home may re-contribute the released amount into superannuation as a non-concessional contribution. The contribution must be made by the time they would have been required to enter into a contract, and the Commissioner must be notified of the action taken by the individual. Liability to FHSS tax An individual is liable to pay First Home Super Saver tax (FHSS tax) if they do not, within the required time: (i) enter into a contract to purchase or construct residential premises, or (ii) re-contribute the released amount into superannuation. The FHSS tax is equal to 20% of the individual’s assessable FHSS released amounts and is due and payable 21 days after the individual receives a notice of assessment of the tax. ATO guidance on the FHSS scheme Super Guidance Note SPR GN 2018/1 contains general information about the FHSS scheme and examples for individuals. Law Companion Ruling LCR 2018/5 lists various contributions that are not eligible for release, including amounts that reduce an employer’s potential superannuation charge liability or that are required to be made under an industrial agreement, government co-contributions and amounts paid due to a contributions splitting arrangement.

¶4-223 Downsizer contributions by individuals aged 65 and over

From 1 July 2018, individuals aged 65 and over may be able to make superannuation contributions of up to $300,000 from the proceeds of selling their home. This is intended to make it easier for older individuals to “downsize” from homes that no longer meet their needs. Under the rules about when a fund can accept contributions (¶4-205), individuals aged 65 or over are generally unable to make personal contributions unless they satisfy the work test. As an exception, superannuation funds can accept downsizer contributions from individuals who have reached 65 regardless of their connection to the work force. A contribution is a downsizer contribution is it satisfies the following conditions: 1. An individual aged 65 years or over makes a contribution to a complying superannuation fund from the capital proceeds received when they dispose of their home located in Australia. 2. The contract for the sale of the home is entered into on or after 1 July 2018. 3. The capital proceeds arise from the disposal of a dwelling that is the individual’s “main residence” for at least part of the ownership period and where the capital proceeds would be at least partially exempt from capital gains tax under the main residence exemption. An individual may in some cases be able to make a contribution from the capital proceeds of selling a pre-CGT asset, ie a property acquired before 20 September 1985. 4. Either the individual or their spouse has owned the home at all times during the 10 years ending when it is sold. The individual is not required to have lived in the property continuously for 10 years, but the property must have been lived in for some of the 10-year period so that it qualifies as the individual’s main residence. 5. Although both the individual and their spouse can make a contribution from the disposal of the same home, the maximum contribution each can make is $300,000. 6. The contribution is made within 90 days, or a longer time allowed by the Commissioner, after the home is disposed of. 7. At or before the contribution is made, the individual notifies the superannuation fund that they choose for the contribution to be treated as a downsizer contribution. A downsizer contribution is excluded from being a non-concessional contribution and does not therefore count towards an individual’s non-concessional contributions cap (¶4-245). A deduction is not allowed for the contribution. The rule that an individual with a total superannuation balance (¶4-233) above $1.6m cannot make nonconcessional contributions does not apply to a downsizer contribution. However, once the downsizer contribution is made it would count towards the individual’s total superannuation balance in later years, potentially limiting the ability to make non-concessional contributions in those later years. ATO guidance Law Companion Ruling LCR 2018/9 and Super Guidance Note SPR GN 2018/2 provide ATO guidance for people aged 65 and over who are considering selling their home and making downsizer contributions.

¶4-225 Tax on concessional contributions of high-income earners Concessional contributions (¶4-234) are generally taxed at 15% when they are paid to a complying superannuation fund. Concessional contributions include employer contributions such as SG contributions and salary sacrifice contributions for an employee and a member’s personal contributions for which a deduction has been allowed. Concessional contributions made on or after 1 July 2017 for individuals with income greater than $250,000 may also be liable for an additional 15% Division 293 tax. For the years 2012/13 to 2016/17, Division 293 tax could apply where an individual’s income was greater than $300,000.

Division 293 tax applies to concessional contributions to accumulation interests and to defined benefit contributions. It does not apply to: • non-concessional contributions (¶4-240) • concessional contributions that exceed the individual’s concessional contributions cap for the year (¶4-234) or excess contributions that are disregarded by the Commissioner (¶4-250) • state higher level office holders in respect of contributions to constitutionally protected funds (unless the contributions are salary packaged contributions), or • Commonwealth judges and justices in respect of contributions for a defined benefits interest in a superannuation fund established under the Judges Pensions Act 1968. Division 293 tax is assessed by the Commissioner and is generally due and payable within 21 days of the Commissioner giving a notice of assessment to the individual. For defined benefit interests, Division 293 tax is generally deferred for payment until 21 days after the first benefit is paid from the individual’s superannuation interest. Individuals are authorised to have amounts released from certain superannuation interests to facilitate payment of the tax. Liability to Division 293 tax An individual is liable for Division 293 tax for an income year if they have “taxable contributions” for the year (ITAA97 s 293-15). From 2017/18, an individual has taxable contributions for an income year if the sum of: • their “income for surcharge purposes” (less “reportable superannuation contributions”), and • their “low tax contributions”, exceeds $250,000. If the $250,000 threshold is exceeded, the individual’s taxable contributions amount is the lesser of the low tax contributions and the amount of the excess over $250,000 (ITAA97 s 293-20). Division 293 tax is imposed at the rate of 15% on the amount of the taxable contributions. “Income for surcharge purposes” means the sum of the individual’s: • taxable income • reportable fringe benefits total (¶3-900) • reportable superannuation contributions, and • total net investment losses, eg from negative gearing (ITAA97 s 995-1(1)). The taxable component of a lump sum superannuation benefit (¶4-420) is not included if an offset reduces the tax on the taxable component to nil. “Reportable superannuation contributions” is the sum of the deductible contributions made for the individual personally and RESCs (¶4-215) made for the individual (ITAA97 s 995-1(1)). An individual’s “low tax contributions” are broadly concessional contributions such as employer contributions made on behalf of the individual and deductible personal contributions made by the individual, but not including the amount of concessional contributions that exceeds the concessional contributions cap (¶4-234) for the year (ITAA97 s 293-25 and 293-30). If an individual’s income, excluding their concessional contributions, is less than $250,000, but the inclusion of their concessional contributions pushes them over the $250,000 threshold, Division 293 tax only applies to the amount of the contributions that is in excess of the threshold. Because Division 293 tax does not apply to concessional contributions that exceed an individual’s concessional contributions cap, the maximum amount of Division 293 tax that can be payable in a year is

15% of the concessional contributions cap, ie for 2020/21, $3,750 ($25,000 × 15%), the same as for the previous three years. Example For 2020/21, Romi has taxable income of $200,000, a reportable fringe benefits total of $35,000 and concessional contributions (not including salary sacrifice contributions) of $28,000. The concessional contributions cap for the year is $25,000. Without the concessional contributions, Romi’s income would be $235,000 and therefore below the $250,000 threshold. When the concessional contributions (not including the $3,000 in excess of the $25,000 cap) are added, the threshold is exceeded. Romi has $10,000 taxable contributions (the amount that, when the concessional contributions are added, is in excess of the $250,000 threshold). Division 293 tax of $1,500 ($10,000 × 15%) is imposed on that $10,000.

Division 293 tax may be paid from an individual’s own money or from superannuation using a release authority issued by the Commissioner. Defined benefit members ITAA97 Subdiv 293-D (s 293-100 to 293-115) provides that an individual’s low tax contributions include notional contributions in respect of defined benefit interests (defined benefit contributions). This ensures that individuals with defined benefit interests are treated in a similar way to individuals with accumulation interests. An individual’s defined benefit contributions for a financial year in respect of a defined benefit interest has the meaning given by the regulations, ie by ITAR reg 293-115.01 to 293-115.20 and Sch 1AA. As the actual value of benefits received by an individual from a defined benefit interest can only be known when the benefit is paid, the regulations provide that an individual’s defined benefit contributions is an estimate of the amount of employer contributions that would be made if contributions to fund all the employerprovided benefits expected to be paid were made annually. Generally, this is the sum of the actuarial value of the employer-provided benefits attributed to the individual for a financial year, the administrative expenses and the risk benefits attributable to the interest. The method for determining defined benefit contributions averages the cost of employer-provided benefits across all defined benefit members and all years of service. There are special rules for accruing members with interests other than funded benefit interests. Generally, these interests are in superannuation funds for Commonwealth, state and territory employees including constitutionally protected funds and certain public sector superannuation schemes. For members with a defined benefit interest, Division 293 tax is included in a debt account and is generally not payable until 21 days after the first benefit is payable from the superannuation interest (Div 133 and 134 of Sch 1 of the TAA). Interest is applied to the outstanding balance of a debt account at the long-term bond rate. The debt amount is capped at 15% of the employer-financed component of the value of the superannuation interest that accrues after 1 July 2012. Members may voluntarily pay their Division 293 tax liability from other sources at an earlier time. Certain “state higher level office holders” do not pay Division 293 tax in respect of contributions to constitutionally protected funds unless the contributions are made as part of a salary package. These office holders include state ministers, judges and magistrates, state governors and state public service departmental heads. Division 293 tax is also not payable by Commonwealth justices and judges in respect of contributions to a defined benefit interest established under the Judges Pensions Act 1968. Former temporary residents Former temporary residents who receive a departing Australia superannuation payment (¶4-435) are entitled to a refund of any Division 293 tax that they have paid (ITAA97 s 293-230). This reflects the fact that any concessional tax treatment of their superannuation contributions is removed by a final withholding tax on the superannuation benefit.

¶4-227 Transfer balance cap rules From 1 July 2017, an individual’s transfer balance cap limits the amount of capital they can transfer to the

“retirement phase” to support a superannuation income stream payable to them. The transfer balance cap is intended to limit the extent to which the superannuation interests of certain individuals attract an earnings tax exemption when they are receiving superannuation income stream benefits. The transfer balance cap is $1.6m for 2020/21, the same as for the previous three years. The transfer balance cap rules are primarily in ITAA97 Div 294, 303 and 307 and TAA Sch 1 Div 136, with transitional provisions in ITTPA Div 294. Background to the introduction of the transfer balance cap — the pre-1 July 2017 rules An individual’s investments in superannuation are generally subject to a 15% earnings tax imposed on the individual’s superannuation fund. When an individual accesses their superannuation, they may choose to receive a superannuation lump sum or a superannuation income stream. If the individual commences a superannuation income stream, income earned from the investment of the capital that supports the income stream may be exempt from tax (the earnings tax exemption) (¶4-320). Before 1 July 2017, there was no limit on the amount an individual could transfer into a superannuation income stream to benefit from the exemption. This provided a tax advantage to high wealth individuals with significant superannuation balances. Summary of the transfer balance cap rules The transfer balance cap rules that apply from 1 July 2017 can be summarised as follows. • An individual has a transfer balance account if they are, or have at any time been, the “retirement phase recipient” of a superannuation income stream. • An individual is generally a retirement phase recipient of a superannuation income stream if a superannuation income stream benefit is payable to them at that time, or a deferred superannuation income stream will be payable to them after that time, from a superannuation income stream, that is “in the retirement phase” (¶4-228). • A superannuation income stream is only entitled to the earnings tax exemption (¶4-320) if it is “in the retirement phase”. • Credits and debits are made to an individual’s transfer balance account at various times (¶4-228). • When an individual first commences a superannuation income stream that is in the retirement phase, their personal transfer balance cap equals the general transfer balance cap for that financial year, ie $1.6m for 2020/21 (¶4-229). • An individual has an excess transfer balance when the balance of their transfer balance account exceeds their personal transfer balance cap, and the Commissioner may make an excess transfer balance determination requiring the individual to take action to remove the excess amount (¶4-230). • The Commissioner must issue a commutation authority to one or more superannuation providers if an individual has not acted on an excess transfer balance determination by the due date (¶4-230). The commutation authority authorises the commutation in full or in part of an individual’s superannuation income stream. • An individual whose transfer balance exceeds their transfer balance cap may be liable to excess transfer balance tax on excess transfer balance earnings accrued while the cap was exceeded (¶4231). • Transitional rules provided CGT relief for complying superannuation funds that held assets for individuals in the retirement phase and needed to reallocate the assets to the accumulation phase before 1 July 2017 in order to comply with the $1.6m transfer balance cap from that date (¶4-231). • The transfer balance cap rules are modified for certain defined benefit income streams that are

subject to commutation restrictions which make some general transfer balance cap rules unworkable, eg the requirement to commute an excess balance and transfer it to the accumulation phase or take it in cash (¶4-232).

¶4-228 Transfer balance account An individual has a transfer balance account if they are, or have at any time been, the “retirement phase recipient” of a superannuation income stream. An individual starts to have a transfer balance account on the later of: (i) 1 July 2017 if they were receiving superannuation income streams on that day, and (ii) the day they first start a superannuation income stream and superannuation income stream benefits are payable to them. A transfer balance account ends when the individual who is the retirement phase recipient of the superannuation income stream dies. “Retirement phase recipient” of a superannuation income stream An individual is a retirement phase recipient of a superannuation income stream at a time if a superannuation income stream benefit: • is payable to the individual at that time from a superannuation income stream that is “in the retirement phase” at that time, or • will be payable to the individual after that time from a superannuation income stream that is in the retirement phase at that time and is a “deferred superannuation income stream”. A deferred superannuation income stream is basically where the rules for the provision of the benefit provide for payments to start more than 12 months after the superannuation interest is acquired and to be made at least annually afterwards (SISR reg 1.03(1)). “In the retirement phase” From 1 July 2017, the earnings tax exemption (¶4-320) applies when a superannuation income stream is “in the retirement phase”. A superannuation income stream is in the retirement phase if: • a superannuation income stream benefit is currently payable from it • it is a deferred superannuation income stream that has not yet become payable but the member has satisfied a condition of release (¶4-400) for retirement, terminal medical condition, permanent incapacity or attaining age 65, or • it is a transition to retirement income stream (TRIS) and the person to whom the benefit is payable (i) is 65 years or older (ii) has satisfied a condition of release (¶4-400) for retirement, terminal medical condition and permanent incapacity, and has notified the superannuation income stream provider that the condition has been satisfied, or (iii) receives the TRIS as a reversionary beneficiary. A TRIS is automatically in the retirement phase if it starts to be paid to a reversionary beneficiary after the member’s death. A reversionary TRIS can automatically transfer to a dependant on the death of the original pension recipient without a condition of release having to be satisfied. The original TRIS does not cease on the original pensioner’s death or a new pension commence when it transfers to the dependant. When the entitlement to a TRIS transfers to a reversionary beneficiary, the reversionary beneficiary

receives a credit to their transfer balance account (see below). The amount of the credit and when it arises depend on the date of death of the member. Superannuation income streams that are not in the retirement phase The following superannuation income streams are excluded from being in the retirement phase and therefore cannot benefit from the earnings tax exemption: • a deferred superannuation income stream that has not become payable and the member has not met a relevant condition of release • a superannuation income stream that fails to comply with the pension or annuity standards under which it is provided • a TRIS where the member has not satisfied a relevant condition of release or has failed to notify the superannuation provider of having done so, or where the benefit is not received by a reversionary beneficiary, and • a superannuation income stream that stops being in the retirement phase because the superannuation provider fails to pay a superannuation lump sum as required by a commutation authority (¶4-230). Changes to a transfer balance account A transfer balance account operates like a bank account, with the value of an individual’s account changing as credit or debit entries are recorded. A credit reduces the amount of available cap space an individual has, and a debit increases the available cap space. Once a superannuation income stream has commenced, changes in the value of its supporting interest are not counted as credits or debits. Increases in value from investment earnings and decreases in value from pension payments or investment losses are not therefore counted towards the cap. Example Ilsa started a pension on 1 July 2017 from a superannuation income stream valued at $950,000. At 1 July 2020 the value of the superannuation interest that supports the pension is $990,000 because of investment earnings. By 1 July 2022, Ilsa has drawn down $250,000 of the superannuation interest that supports the pension. Ilsa started to have a transfer balance account on 1 July 2017, and the balance of the account at all times is $950,000. This reflects the credit that arose on 1 July 2017 when she started the pension.

Credits to a transfer balance account The following amounts are credited towards an individual’s transfer balance account: 1. the value of superannuation interests that support superannuation income streams in the retirement phase the individual was receiving on 30 June 2017 2. the commencement value of new superannuation income streams in the retirement phase the individual starts to receive on or after 1 July 2017, and 3. excess transfer balance earnings on excess transfer balance amounts. An individual has an excess transfer balance when the balance of their account exceeds their personal transfer balance cap on a particular day. The earnings compound daily until the breach of the transfer balance cap is rectified or the Commissioner issues a determination (¶4-230). An excess transfer balance is disregarded if: (i) it is less than $100,000 (ii) is caused by existing superannuation income streams on 30 June 2017, and (iii) the individual rectifies the breach within six months (¶4-231).

Law Companion Ruling LCR 2016/9 provides guidance on transfer balance credits. Credit where a payment is made in respect of a limited recourse borrowing arrangement There may also be a credit to an individual’s transfer balance account where an SMSF or a small APRA fund makes a payment in respect of a LRBA (¶5-360) that increases the value of a superannuation interest supporting a retirement phase superannuation income stream. The credit arises at the time of the payment and the amount of the credit is the amount by which the individual’s superannuation income stream increases in value because of the payment. This means the credit can only arise where the payments are sourced from assets that do not support the same income stream, eg from assets that support accumulation interests in the fund. Generally, a credit only arises from payments relating to LRBAs where the contract for the borrowing is entered into on or after 1 July 2017, and not to contracts entered into before 1 July 2017 but completed after that date. A credit does not arise where there is a refinancing of the outstanding balance of borrowings arising under contracts entered into before 1 July 2017, although this exemption is only available if the refinancing arrangement applies to the same asset and the refinanced amount is not greater than the outstanding balance on the LRBA just before the refinancing. Credit arising from death benefit income streams A superannuation death benefit (¶4-425) may be paid either as a superannuation income stream or as a lump sum if the beneficiary is a dependant of the deceased member. This means the benefit is paid to a person who is: (i) a spouse, (ii) a child of the deceased less than 18 years, (iii) financially dependent or with a disability, or (iv) a person who was in an interdependency relationship with the deceased. Payments to non-dependants must be made as a lump sum. In the case of a non-reversionary death benefit income stream, the value of the supporting superannuation interest is credited to the beneficiary’s transfer balance account on the later of 1 July 2017 and the day the benefit is payable to the beneficiary. In the case of a reversionary death benefit income stream, a credit for the value of the supporting superannuation interest does not arise in the beneficiary’s transfer balance account until 12 months after the superannuation income stream benefit first becomes payable to the beneficiary. This deferral gives the beneficiary time to adjust their affairs following the death of the member before consequences such as a breach of their transfer balance cap arise. The amount that is credited may include investment gains that accrued to the deceased’s superannuation interest between the time the person died and the income stream became payable to the beneficiary. If a death benefit income stream, in combination with an individual’s own superannuation income stream, results in a beneficiary exceeding their transfer balance cap, they will need to decide which superannuation income stream to commute. A superannuation death benefit cannot be held in an accumulation interest as this contravenes the regulatory requirement to cash the benefit as soon as practicable. The ATO’s views on reversionary and non-reversionary income streams and the timing of transfer balance credits are set out in Law Companion Ruling LCR 2017/3. As a general rule: • a reversionary death benefit income stream is a superannuation income stream that reverts to the reversionary beneficiary automatically upon the member’s death; the superannuation income stream continues with the entitlement to it passing from one person (the member) to another (the dependant beneficiary), and • a non-reversionary death benefit income stream is a new superannuation income stream where the superannuation provider has the power or discretion to determine the recipient, the form in which the death benefit will be paid, eg as a superannuation lump sum or a superannuation income stream, or the amount of the death benefit. Debits to a transfer balance account An individual’s transfer balance account is debited when superannuation income streams that were

previously credited (because they receive the earnings tax exemption) are reduced by capital being commuted or because the earnings tax exemption is lost. This ensures that an individual’s transfer balance reflects the net amount of capital the individual has transferred to the retirement phase of superannuation. Pension drawdowns are not debited from an individual’s transfer balance. This reflects the expectation that, once an individual has used their transfer balance cap, the value of their retirement phase assets will decline as they use this income to support themselves in their retirement. In a recent case (Lacey v FC of T [2019] AATA 4246), a taxpayer became liable to excess transfer balance tax (¶4-231) after he incorrectly assumed that his pension drawdowns would reduce his transfer balance account below the transfer balance cap. A debit arises in the transfer balance account in the following cases: • full or partial commutation of a superannuation income stream in the retirement phase to a superannuation lump sum • a structured settlement amount an individual receives for personal injury is contributed towards their superannuation interests • an individual loses some or all of the value in their superannuation interest because of family law payment splits, fraud or void transactions under the Bankruptcy Act 1966 • a superannuation income stream provider does not comply with a commutation authority (¶4-230) — a debit equal to the value of the superannuation income stream arises to reflect that the income stream is no longer in the retirement phase, and • an individual has insufficient superannuation interests to rectify an excess transfer balance (¶4-230) — a debit arises to write off the excess transfer balance. Law Companion Ruling LCR 2016/9 provides guidance on transfer balance debits.

¶4-229 Transfer balance cap When an individual first commences a retirement phase (¶4-228) superannuation income stream, their personal transfer balance cap equals the general transfer balance cap for that financial year. The general transfer balance cap is $1.6m for the 2020/21 financial year, the same as it was for the previous three years. The general transfer balance cap is subject to indexation in $100,000 increments on an annual basis in line with the Consumer Price Index (CPI). CPI increases for 2017/18, 2018/19 and 2019/20 were not sufficient for the transfer balance cap to be indexed for those years. Proportional indexation of the personal transfer balance cap Where an individual starts to have a transfer balance account and has not used the full amount of their cap, their personal transfer balance cap is subject to proportional indexation in line with increases in the general transfer balance cap. Proportional indexation is intended to keep constant the proportion of an individual’s used and unused cap space as the general transfer balance cap increases. Indexation is only applied to an individual’s unused cap percentage. This is worked out by finding the individual’s highest transfer balance at the end of a day at an earlier point in time, comparing it to their personal transfer balance cap on that day and expressing the unused cap space as a percentage. Once a proportion of cap space is used, it is not subject to indexation, even if the individual subsequently removes capital from their retirement phase. Example Singh first commenced a $960,000 retirement phase superannuation income stream on 1 July 2017 and there are no further credits to his transfer balance account. Singh’s highest transfer balance is $960,000 which means that, at that time, he has used 60% of his $1.6m personal transfer balance cap.

Assuming the general transfer balance cap is indexed to $1.7m in 2022/23, Singh’s personal transfer balance cap is increased proportionally to $1.02m. Singh’s personal transfer balance cap is increased by 60% of the corresponding increase to the general transfer balance cap.

Law Companion Ruling LCR 2016/9 provides guidance on how the transfer balance cap operates for account-based superannuation income streams. Modified transfer balance cap for death benefit income streams payable to a child Death benefit reversionary pensions paid to a child from income streams payable to the deceased prior to death come within the child’s transfer balance cap. Other amounts payable as death benefits to the child must be cashed as lump sums. The transfer balance cap that applies to a child dependant in receipt of a reversionary pension is modified so that the child can generally receive their share of the deceased’s retirement phase interest without prejudice to the child’s future retirement. This recognises that child dependants are generally required to commute a death benefit income stream by age 25, at which time their transfer balance account and modified transfer balance cap cease. An exception applies where the child recipient has a permanent disability and is not required to cash the pension. The personal transfer balance cap of a child who is only receiving death benefit income streams as a child recipient is not set to the indexed value of the general transfer balance cap, but is generally determined by reference to the value of the deceased’s retirement phase interests that they receive.

¶4-230 Excess transfer balance determinations An individual has an excess transfer balance if the balance of their transfer balance account (¶4-228) exceeds their personal transfer balance cap (¶4-229) on a particular day. If an individual has more than one superannuation pension account in the retirement phase, the transfer balance cap applies to the combined amount in the accounts. This could include, for example, a pension from a deceased spouse’s superannuation account or pension income from a former spouse’s superannuation pension as part of a Family Court settlement. Guidance Note GN 2017/1 provides ATO guidance on the transfer balance cap for retirement phase accounts that commence on or after 1 July 2017. The ATO emphasises that members should keep track of their transfer balance account to make sure they do not exceed the cap and that transfers into the retirement phase need to be managed. Example When Wally retired on 1 June 2020, he had an accumulated superannuation balance of $1.85m. He can transfer $1.6m into a retirement phase account to support a pension income stream without exceeding his transfer balance cap. The remaining $250,000 can be kept in an accumulation account or can be withdrawn from superannuation as a cash lump sum. Once he has transferred $1.6m into the retirement income account, Wally cannot make any additional contributions to that account, even if there are fluctuations to the account from investment earnings or the drawdown of pension payments.

If an individual has excess transfer balance, the Commissioner may require the superannuation income stream to be fully or partly commuted so that the amount of the individual’s income streams that are in the retirement phase is reduced. Individuals already in retirement before 1 July 2017 with transfer balances in excess of the cap at 30 June 2017 were required to either withdraw the excess amounts from superannuation or transfer the excess amounts into an accumulation account. Transitional arrangements applied for balances that exceeded the cap by no more than $100,000 (¶4231). Transitional relief was also available to ameliorate the CGT consequences where superannuation funds needed to transfer assets from the retirement phase to the accumulation phase before 1 July 2017 (¶4-

231). Certain defined benefit income streams are not required to be reduced if their value exceeds the transfer balance cap, but defined benefit pension payments are subject to additional taxation consequences (¶4232). Commutation requests made before 1 July 2017 by a member of an SMSF to avoid exceeding the transfer balance cap may have faced the problem that the member did not, at that time, know precisely the value of the superannuation interests that supported their superannuation income streams. The ATO states in Practical Compliance Guideline PCG 2017/5 that an acceptable approach in these circumstances was for the member to make an irrevocable request to commute their income stream by the amount that exceeded $1.6m at 30 June 2017. The commutation request and acceptance by the fund trustee had to be made in writing before 1 July 2017 and to specify the superannuation income stream and a methodology for calculating the precise amount to be commuted. Individual advised of their excess transfer balance When an individual has an excess transfer balance, the Commissioner may make a written excess transfer balance determination stating the amount of the excess (the “crystallised reduction amount”). The Commissioner’s determination must include a “default commutation notice” stating that, if the individual does not make an election by the specified date to commute a superannuation income stream, the Commissioner will issue a commutation authority (see “Commutation authorities” below). An individual may make an election for the commutation of an income stream, and the irrevocable election must generally be made within 60 days from the date the determination was issued. The total amount elected to be commuted must equal the crystallised reduction amount. An individual does not need to make an election if the superannuation income stream they wish to be commuted is the superannuation income stream included in the Commissioner’s default commutation notice. Where an individual has already taken steps to rectify their breach and has removed their excess transfer balance, the Commissioner is not required to issue a determination but the individual may still be liable for excess transfer balance tax (¶4-231). An individual who is dissatisfied with an excess transfer balance determination issued to them may object within 60 days from the date the determination is served on them. From January 2018, the ATO started sending excess transfer balance determinations to individuals who have exceeded their transfer balance cap and not rectified the excess. The ATO reminds SMSF members on its website that: • the sooner a member removes the amount set out in the determination out of retirement phase, the less excess transfer balance tax they will pay • if the SMSF trustee has not already reported information to the ATO for the member, they must do so as soon as possible. If additional time is needed, the member can request an extension of time • the member must commute the amount set out in the determination from retirement phase. Removing it by making a large pension payment will not result in a debit in their transfer balance account, so they will still be in excess of their transfer balance cap • unless the member is commuting a death benefit income stream, they do not need to remove the amount set out in the determination from the super system. The excess may be kept in an accumulation phase account, and • the trustee must ensure that the minimum pension payment standards are met at the time they commute the income stream. Commutation authorities The Commissioner may issue a commutation authority when an individual has an excess transfer

balance. The purpose is for the amount of the individual’s excess to be removed and the transfer balance brought back to the individual’s transfer balance cap. The Commissioner must issue a commutation authority if: (i) an excess transfer balance determination has been issued to an individual and has not been revoked; (ii) the period within which an election may be made by the individual, generally 60 days, has ended; and (iii) an amount remains after the crystallised reduction amount has been reduced by any debits to the transfer balance account arising from a commutation since the determination was issued and notified to the Commissioner. A commutation authority must specify the superannuation income stream to be commuted in full or in part and the amount by which the superannuation income stream is to be reduced. A superannuation income stream provider issued with a commutation authority must, within 60 days, pay by way of commutation a superannuation lump sum equal to the lesser of: • the amount stated in the commutation authority, and • the “maximum available release amount”, ie the total amount of all superannuation lump sums that could be paid from the superannuation interest at that time. The superannuation income stream provider should consult the individual on whether they wish the commutation amount to remain within superannuation in an accumulation account or, if the individual meets a relevant condition of release, to be paid as a superannuation lump sum. A superannuation income stream provider must, within 60 days, notify the Commissioner and the individual of the commuted amount or that the commutation authority will not be complied with because the superannuation income stream is a capped defined benefit income stream (¶4-232). If an individual has an excess transfer balance but no remaining superannuation income streams from which the excess can be commuted, the Commissioner must notify the individual that they have a noncommutable excess transfer balance and a debit for the excess is applied to the individual’s transfer balance account (¶4-228). This effectively writes off the remainder of the excess so that excess transfer balance earnings do not continue to accrue. Consequences of not complying with a commutation authority Where a superannuation income stream provider fails to comply with a commutation authority: • the relevant superannuation income stream is no longer in the retirement phase and does not qualify for the earnings tax exemption from the start of the financial year in which the non-compliance occurred • a debit arises in the individual’s transfer balance account for the value of the superannuation interest that supports the superannuation income stream that has ceased to be in the retirement phase, which generally will mean the individual no longer has an excess transfer balance, and • if the individual wishes to again have a superannuation income stream that qualifies for the earnings tax exemption, they would need to commute the superannuation income stream in full and start a new superannuation income stream.

¶4-231 Excess transfer balance tax An individual who has an excess transfer balance is liable to excess transfer balance tax on the excess transfer balance earnings accrued while the cap was exceeded. Excess transfer balance tax is not deductible (ITAA97 s 26-99). For first breaches of the transfer balance cap (whether in 2017/18 or in a later year), the tax rate is set at 15%, which broadly replicates the outcome if the excess capital had been in the accumulation phase. For subsequent breaches, the tax rate is 30%. The tax is imposed by the Superannuation (Excess Transfer Balance Tax) Imposition Act 2016. Excess transfer balance tax is applied to the accrued amount of an individual’s excess transfer balance

earnings over a period the individual had an excess transfer balance. The earnings are calculated from the date the individual’s transfer balance first exceeds their transfer balance cap to the date when the transfer balance is no longer in excess. Excess transfer balance earnings accrue daily on excess transfer balances at a rate based on the general interest charge. Excess transfer balance tax is due and payable at the end of 21 days after the Commissioner gives an individual notice of the assessment of the amount of the tax. If the tax is not paid by the due date, general interest charge starts accruing on the unpaid amount. The Commissioner has no discretion to waive an excess transfer balance tax liability resulting from taxpayer error or oversight, no matter how minor or genuine (Vernik v FC of T 2019 ATC ¶10-508; [2019] AATA 3754, Jacobs v FC of T 2019 ATC ¶10-502; [2019] AATA 1726). In Vernik, the taxpayer submitted that it was unfair to be taxed with respect to the period from 1 July 2017 when he was not informed that he had an excess transfer balance until 3 January 2018. If he had been informed earlier, he would have made the requested payment earlier, and thereby incurred a lesser tax liability. The AAT rejected the taxpayer’s submission, noting that the determination period on which the tax liability was based was not determined by reference to when the taxpayer was first informed of his excess transfer balance. Nor did a taxpayer avoid a tax liability by complying with a request to commute funds out of his or her superannuation income streams. In Jacobs, the taxpayer had sought advice from the ATO as to how the “special value” of the relevant income stream should be calculated under ITAA 1997 s 294-135 and then calculated his transfer balance cap on the information he had available to him at the time. Despite his best endeavours, his superannuation transfer balance on 1 July 2017 was over $1.6m and he incurred an excess transfer balance tax liability of $260. The taxpayer argued that the lack of discretion to resolve cases where people have made relatively minor or genuine errors was grossly unfair. Be that as it may, the AAT observed that no such discretion existed in the legislation (ITAA Div 294) and affirmed the objection decision. Transitional relief for small excess transfer balances at 30 June 2017 Transitional rules apply to excess transfer balances where: (a) the only transfer balance credits in the individual’s transfer balance account (¶4-228) in the sixmonth period beginning on 1 July 2017 related to superannuation income streams the individual had just before 1 July 2017 (b) the sum of those transfer balance credits exceeded the individual’s transfer balance cap, but was less than or equal to $1,700,000, and (c) at the end of the six-month period from 1 July 2017, the sum of all the transfer balance debits arising in the transfer balance account equalled or exceeded the amount of the excess from para (b). The purpose of this transitional rule was to ensure that transfer balance cap breaches of less than $100,000 that occurred on 30 June 2017 were not penalised as long as they were rectified within six months. The assumption was that such small breaches were likely to be unintentional, because it may have been difficult for individuals with existing superannuation income streams to predict their retirement phase balances at 30 June 2017 and ensure they were not in breach of their $1.6m transfer balance cap. Transitional CGT relief when assets transferred from retirement phase Under the pre-1 July 2017 law, capital gains on the disposal of assets that supported a superannuation income stream could be exempt from tax (the earnings tax exemption: ¶4-320). From 1 July 2017, an individual with a transfer balance over the transfer balance cap ($1.6m for 2020/21 and the previous three years) is required to commute or roll back the excess amount to the accumulation phase, with earnings on the transferred amount subject to 15% tax. This could make a fund liable to CGT on capital gains accumulated before 1 July 2017 where the gains would, in the absence of the new law, have been exempt income. Transitional CGT relief was introduced to ameliorate this potential consequence. Under the transitional provisions, complying superannuation funds were able to reset the cost base of assets to their market

value where those assets were reallocated or reapportioned from the retirement phase to the accumulation phase before 1 July 2017 in order to comply with the transfer balance cap rules. CGT relief was available if: • the reallocation or reapportionment from the retirement phase took place during the period 9 November 2016 to 30 June 2017 in relation to assets held by a complying superannuation fund through that period, and • the superannuation fund made an irrevocable choice to apply the relief and notified the choice to the Commissioner by the day the trustee is required to lodge the fund’s 2016/17 income tax return. The CGT relief operated on an asset-by-asset basis and had the effect that: (a) the fund was deemed to have sold and reacquired the relevant asset for market value at the following times: (i) if the asset was a segregated pension asset for the purposes of the earnings tax exemption on 9 November 2016 and stopped being a segregated pension asset before 1 July 2017 — on the day it stopped being a segregated pension asset, or (ii) if the fund obtained an actuarial certificate to claim an exemption based on a proportion of its assets — immediately before 1 July 2017 (b) the deemed sale triggered CGT event A1 and resulted in the reacquired asset having its cost base set at its current market value (c) when the asset is sold after 1 July 2017, a capital gain only arises in relation to capital growth that accrued to the asset after the CGT relief was applied, ie once the asset is no longer supporting superannuation interests in the retirement phase (d) the 12-month eligibility period for the CGT discount commences on the date the asset is deemed to be sold and reacquired, and (e) any subsequent events that could affect the asset’s cost base apply to the reset cost base amount. Law Companion Ruling LCR 2016/8 sets out the Commissioner’s approach to the transitional CGT relief. The Commissioner warns in the ruling that the anti-avoidance provisions in ITAA36 Pt IVA (¶1-610) could apply if a superannuation trustee entered into a scheme for the main purpose of placing the trustee in a position to be able to choose the CGT relief so as to obtain a tax benefit. If a scheme goes further than is necessary to comply with the transfer balance cap reforms, and involves additional steps unnecessary for that purpose but necessary to obtain a tax benefit, the Commissioner will generally infer that the scheme was entered into for the purpose of obtaining a tax benefit. Merely commencing a pension during the period 9 November 2016 to 30 June 2017 was not of concern from a Pt IVA perspective, but a commutation of the pension shortly after its commencement might suggest the purpose of obtaining a tax benefit.

¶4-232 Modified transfer balance cap rules for capped defined benefit income streams Many defined benefit superannuation income streams are subject to commutation restrictions which make some of the transfer balance cap rules unworkable, eg the requirement to commute an excess balance and transfer it to the accumulation phase or take it in cash. As a result, the transfer balance cap rules have been modified so that they apply appropriately to those defined benefit income streams. The purpose of the modifications is to accord taxation treatment to certain non-commutable superannuation income streams that is commensurate with the treatment accorded to other income streams under the transfer balance cap rules. The modifications: (i) change the valuation rules

(ii) prevent an individual from having an excess transfer balance in certain circumstances, and (iii) change the tax treatment of a superannuation income stream benefit. Capped defined benefit income streams The modifications apply to “capped defined benefit income streams”, basically superannuation income streams that are subject to commutation restrictions. Two categories of superannuation income streams are affected: (1) lifetime pensions (whether they existed at 30 June 2017 or commenced after that date), which are often provided to Commonwealth, state and territory public office holders and military and civilian employees and meet the standards in SISR reg 1.06(2) — this means they are paid at least annually throughout the life of the primary beneficiary with the size of the pension payments in a given year fixed, the amount paid as a benefit in each year cannot be reduced except if the CPI falls, and the income stream can only be commuted to a lump sum amount in very limited circumstances including within six months of the pension commencing, and (2) other superannuation income streams that already existed at 30 June 2017 — this covers certain lifetime annuities, life expectancy pensions and annuities and market-linked annuities and pensions. A superannuation income stream may also be a capped defined benefit income stream if it is prescribed as such by the following regulations. • SISR reg 1.06A prescribes certain innovative superannuation income streams and applies in relation to a benefit provided under fund rules or a contract made on or after 1 July 2017. An income stream comes within reg 1.06A if: (i) the benefit cannot commence before the primary beneficiary has retired, has a terminal medical condition, is permanently incapacitated or has reached age 65 (ii) benefits are payable throughout the life of the beneficiary (iii) payments are not unreasonably deferred after they start, and (iv) there are commutation restrictions on access to capital. • ITAR reg 294-130.01 prescribes: (i) lifetime pensions where commutation is permitted outside of six months of the commencement day (ii) reversionary pensions that allow a child beneficiary to commute at any time (iii) lifetime pensions where the reversionary beneficiary may commute, even if the primary beneficiary has been receiving the pension for more than 20 years (iv) public sector scheme invalidity pensions that can be varied, suspended or terminated in certain circumstances (v) certain income streams arising from the payment of an involuntary roll-over superannuation fund to a successor fund, and (vi) certain partial invalidity pensions provided by public service schemes. Special value of capped defined benefit income streams An individual may determine the “special value” of a capped defined benefit income stream for the purposes of their transfer balance account. The special value of a superannuation interest that supports a lifetime pension or a lifetime annuity is worked out by multiplying the annual entitlement by a factor of 16. An individual’s annual entitlement is

worked out by annualising the first income stream benefit payable from the income stream across an income year. Subsequent increases to the income stream benefit due to indexation are not relevant to the calculation of the annual entitlement. The use of a factor of 16 means that a pension that pays $100,000 per annum would fully exhaust the $1.6m transfer balance cap. The special value of life expectancy pensions and annuities and market-linked pensions and annuities is worked out by multiplying the annual entitlement by the number of years remaining on the term of the product. Example Bron purchases a market-linked pension in January 2020 with a term of five years. At 30 June 2020, the pension has an annual entitlement of $70,000. The remaining term is rounded up to five years, giving the pension a special value of $350,000.

The special value rules are used to determine the amount of credits and debits that arise in relation to capped defined benefit income streams. Where an individual receives a capped defined benefit income stream, a credit arises in their transfer balance account equal to the special value of the superannuation interest that supports the income stream. Where a life expectancy or market-linked pension or annuity being paid before 1 July 2017 becomes payable to a reversionary beneficiary on or after 1 July 2017, the credit that arises in the beneficiary’s transfer balance account is equal to the special value of the superannuation interest that supports that income stream on the date it first becomes payable to the beneficiary. The credit arises in the transfer balance account 12 months later. A transfer balance debit arises: (i) for a full commutation of a superannuation income stream — equal to the income stream’s debit value at that time (ii) for a partial commutation — equal to a proportion of the income stream’s debit value, worked out by subtracting from 1 the special value of the income stream immediately after the commutation divided by the special value of the income stream immediately before that time, and (iii) where an income stream ceases to be in the retirement phase — equal to the income stream’s debit value. The debit amount that arises is worked out by reference to the superannuation income stream’s “debit value” which is generally: (i) for a lifetime pension or annuity, the residual of its starting special value taking into account previous associated debit amounts, and (ii) for a life expectancy or market-linked pension or annuity, its special value at the relevant time. Excess transfer balance If an individual only has a capped defined benefit income stream, the transfer balance in their transfer balance account can never exceed their capped defined benefit balance, which means there is not an excess transfer balance. An individual may have an excess transfer balance if they have both a capped defined benefit income stream and another superannuation income stream. The individual may choose to fully or partly commute the other superannuation income stream to reduce the balance of their transfer balance account below their transfer balance cap. If the value of the superannuation interest supporting the other superannuation income stream is reduced to nil, so that the individual only has the capped defined benefit income stream, the Commissioner will issue a notice to the individual. A debit arises in the individual’s transfer balance account at that time

equal to the amount of the excess transfer balance stated in the notice. As a consequence, the individual will have to cease an excess transfer balance in their transfer balance account (Law Companion Ruling LCR 2016/10). Income tax consequences Capped defined benefit income streams do not, of themselves, result in an excess transfer balance (¶4230) for an individual. Income tax consequences may, however, arise for an individual with defined benefit pension or annuity income that exceeds the defined benefit income cap for a financial year. The defined benefit income cap is $100,000 per annum. These consequences are that: (a) for benefits paid from a taxed element, 50% of the excess may be included in the individual’s assessable income and taxed at marginal rates, or (b) for benefits paid from an untaxed element, the 10% tax offset may be limited to the first $100,000 of defined benefit income the individual receives (¶4-420). ATO guidance Law Companion Ruling LCR 2016/10 provides commentary and examples on lifetime pensions and annuities that are capped defined benefit income streams. Law Companion Ruling LCR 2017/1 clarifies how the defined benefit income cap applies to superannuation income stream pensions or annuities that are paid from non-commutable life expectancy or market-linked products.

¶4-233 Total superannuation balance The concept of a “total superannuation balance” is used from 1 July 2017 to value an individual’s total superannuation interests. It is broadly the amount the individual has in superannuation at a particular time, including amounts in pension and accumulation phase. An individual’s total superannuation balance is used to determine their superannuation rights and entitlements for an income year and is generally tested at 30 June of the prior income year. Significance of the total superannuation balance To be eligible for the following concessions from 2017/18, an individual’s total superannuation balance must be less than the general transfer balance cap (¶4-229), ie $1.6m for 2020/21 and the previous three years, at 30 June in the previous financial year: 1. to be eligible to make non-concessional contributions or to bring forward non-concessional contributions for the next two years (¶4-240) 2. to receive a government co-contribution (¶4-265) 3. to receive a tax offset for spouse contributions (¶4-275) — in this case, it is the spouse’s total superannuation balance that is tested against the general transfer balance cap 4. to increase the basic concessional contributions cap by catch-up contributions (¶4-234) — the total superannuation balance in this case must be under $500,000 at 30 June of the previous financial year, and 5. to be eligible for the exemption from the work test for individuals aged 65 to 74 with a total superannuation balance below $300,000 — eligible individuals can make personal contributions for 12 months from the end of the financial year in which they last met the work test (¶4-205). The total superannuation balance is also used to determine if an SMSF or a small APRA fund is able to use the segregated assets method for determining exempt current pension income in a financial year (¶4320). These funds must use the proportionate method for the full year if: (i) the fund has at least one

member who has a superannuation interest in the fund that is in the retirement phase, and (ii) at the end of 30 June of the previous financial year, the individual has a total superannuation balance that exceeds the general transfer balance cap and is a retirement phase recipient (¶4-228) of a superannuation income stream. The government proposed in the 2019 Federal Budget that a superannuation fund with interests in both the accumulation and retirement phases during an income would be allowed, from 1 July 2020, to choose their preferred method, but this proposal has not yet become law. Calculation of the total superannuation balance An individual’s total superannuation balance at a particular time is calculated as the sum of: 1. the accumulation phase value of their superannuation interests that are not in the retirement phase (¶4-227), ie generally the total amount of superannuation benefits that would become payable if the individual voluntarily caused the superannuation interest to cease at that time, or an amount as calculated according to the regulations. TRISs, non-commutable allocated pensions or annuities, and deferred superannuation income streams that are not yet payable may be included in the accumulation phase value 2. the retirement phase value of their superannuation interests, which is the balance of their transfer balance account (generally, the commencement value of a superannuation pension). An individual’s transfer balance is adjusted: (i) to reflect the current value of account-based superannuation interests in the retirement phase; and (ii) to disregard any debits that have arisen in respect of structured settlements 3. any roll-over superannuation benefits paid at or before that time and received by the fund after that time, and not reflected in the individual’s accumulation phase value or balance of their transfer balance account (the amount may, for example, be in transit because it is rolled over at the end of a financial year), and 4. certain LRBA amounts (see below), reduced by structured settlement contributions. Structured settlement contributions are excluded from the total superannuation balance calculations to recognise that these are usually large payments that can provide the funds for ongoing medical and care expenses resulting from serious injury and income loss. Where an individual’s total superannuation balance was calculated on 30 June 2017, the calculation of their transfer balance was based on the credits to their transfer balance account that arose at the start of 1 July 2017 (because of existing superannuation income streams) less payment split debits that might apply to those income streams on 1 July 2017. Law Companion Ruling LCR 2016/12 provides guidance on the calculation of an individual’s total superannuation balance. The Ruling includes examples relating to: (i) an account-based pension and defined benefit lifetime pension (ii) partial commutation of an account-based annuity (iii) excess transfer balance credit (iv) a roll-over superannuation benefit (v) a structured settlement contribution (vi) structured settlement contribution split between an account-based pension and a lifetime pension (vii) transitional arrangements at 30 June 2017 for an account-based pension (viii) transitional arrangement at 30 June 2017 for a structured settlement contribution and payment split, and (ix) LRBAs.

Limited recourse borrowing arrangement amounts A member’s share of the outstanding balance of certain limited recourse borrowing arrangements (LRBAs) may be included in their total superannuation balance. This applies to borrowings arising under contracts entered into on or after 1 July 2018, but not to the refinancing of the outstanding balance of borrowings arising under contracts entered into before that date. An increase to an individual’s total superannuation balance can only occur where: 1. the LRBA is entered into by the trustee of an SMSF or a fund that has fewer than five members and the fund has used the borrowing to acquire assets that are supporting the superannuation interests of the individual when the total superannuation balance is determined, and 2. the borrowing has not been repaid at the time of working out the total superannuation balance, and: (i) the member has satisfied a nil condition of release relating to retirement, terminal medical condition, permanent incapacity or attaining age 65, or (ii) the lender is an “associate” (as defined in ITAA36 s 318) of the superannuation provider. Where an increase applies solely because one or more members have satisfied a nil condition of release, the increase is only applied in respect of those members. It would not apply to other members, even though their interests may be supported by the same assets to which the LRBAs relate. Where an increase applies because the LRBA is with an associate, all members whose interests are supported by the assets to which the arrangement relates would have their total superannuation balance adjusted. The increase to the total superannuation balance is calculated as a proportion of the outstanding balance of the LRBA. This proportion is based on the individual’s share of the total superannuation interests that are supported by the asset that is subject to the LRBA.

¶4-234 Excess concessional contributions Penalties may be imposed on a superannuation fund member for whom concessional contributions are made in a year in excess of the concessional contributions cap. There are two types of penalties: (1) from 2013/14, excess concessional contributions are included in the member’s assessable income and taxed at marginal rates, and an excess concessional contributions charge may also be imposed, and (2) before 2013/14, excess concessional contributions tax of 31.5% was imposed on the excess concessional contributions. The imposition of penalties on excess concessional contributions is discussed at ¶4-235. The tax treatment of excess non-concessional contributions is discussed at ¶4-240. Concessional contributions cap An individual has excess concessional contributions if the amount of their concessional contributions for an income year exceeds their concessional contributions cap for the year. For 2020/21 (and the previous three years), the basic concessional contributions cap is $25,000, and this cap applies to all individuals. For earlier years, a higher cap applied for older individuals. The concessional contributions cap may be indexed from year to year, but only if indexation would increase the cap by at least $2,500. For years before 2017/18, the concessional contributions cap was increased if indexation would increase the cap by at least $5,000. Individuals with a total superannuation balance (¶4-233) below $500,000 who do not fully use their concessional contributions cap may be allowed to make additional concessional contributions for unused cap amounts. See “Basic concessional contributions cap may be increased by catch-up contributions” below.

Concessional contributions Concessional contributions are contributions that are included in the assessable income of the recipient superannuation fund. Most commonly, concessional contributions are: • employer contributions, whether SG contributions, additional voluntary employer contributions or employer contributions made after an employee enters into a salary sacrifice arrangement, and • personal contributions for which the member has claimed a deduction. Amounts allocated from a reserve for a member according to conditions set out in the regulations are treated as concessional contributions. These conditions generally require a trustee who receives a contribution in a month to allocate the contribution to a member within 28 days after the end of the month or, if this is not reasonably practicable, within a reasonable time. Concessional contributions that are split by a member with their spouse (¶4-260) are counted in determining whether the member (not the spouse) has exceeded the concessional contributions cap, because those contributions will have been taxed when originally paid to the fund for the member. Concessional contributions do not include contributions made for a spouse or for a child aged under 18 unless the spouse or child is an employee of the contributor, but they do include contributions made for other family members even if not deductible. Concessional contributions also do not include: • an amount transferred to a complying superannuation fund from a foreign superannuation fund where the former member of the foreign fund chooses that the amount be included in the assessable income of the receiving fund rather than the member being taxed on the amount (¶4-650), or • a roll-over superannuation benefit that an individual is taken to receive, to the extent that it consists of an element untaxed in the fund and is not an excess untaxed roll-over amount (¶4-430). Defined benefit interests Concessional contributions are defined differently where the member has a defined benefit interest, ie where the benefit payable to the person is defined by reference to the person’s salary, a specified amount or specified conversion factors. Where a member has a defined benefit interest, employer contributions may not be attributable to each individual member and, in such a case, the calculation of a member’s concessional contributions is based on their “notional taxed contributions” as calculated according to the regulations. Before 1 July 2017, the concessional contributions amount for a defined benefit interest was basically an individual’s notional taxed contributions. From 1 July 2017, an additional amount is included in an individual’s concessional contributions to ensure the concessional contributions amount better reflects the full amount of accrued benefits for the defined benefit interest for the financial year. The additional amount is the amount by which the defined benefit contributions for the defined benefit interest exceed the notional taxed contributions for the interest. For schemes that are unfunded or partially unfunded, the individual’s defined benefit contributions will typically be greater than their notional taxed contributions and they will therefore have an additional amount to include in their concessional contributions. Because the amount of notional taxed contributions for a member of a defined benefit scheme is largely beyond the member’s control, grandfathering arrangements apply to some members with notional taxed contributions in excess of the concessional contributions cap. These arrangements have the effect that the notional taxed contributions for the member’s defined benefit interest may be taken to be at, and not in excess of, the concessional contributions cap. To be eligible for the grandfathering provisions, an individual must: • for 2009/10 onwards, have been a member of an eligible defined benefit fund on 12 May 2009 • not have had a substantial change to the rules of their benefit since that date, and

• not have had a non-arm’s length change to their salary of more than 50% in a year or 75% in three years since that date. Constitutionally protected funds and unfunded defined benefit schemes From 1 July 2017, contributions to constitutionally protected funds and certain other amounts relating to constitutionally protected funds and unfunded defined benefit schemes are included in a taxpayer’s concessional contributions and count towards their concessional contributions cap in the same way as they would for other superannuation funds. Concessional contributions included as a result are not treated as excess concessional contributions and taxed as such, but the fact that they are counted towards an individual’s concessional contributions cap limits the individual’s ability to make further concessional contributions. Members would have excess concessional contributions if they have other concessional contributions and, as a result, their total concessional contributions exceed the cap. Before 1 July 2017, these amounts did not count towards a member’s concessional contributions cap and members of constitutionally protected funds and unfunded defined benefit schemes were able to make additional concessional contributions to other superannuation funds. Law Companion Ruling LCR 2016/11 explains how concessional contributions are calculated for defined benefit interests and constitutionally protected funds from 1 July 2017. The amount included in an individual’s concessional contributions from 1 July 2017 will reflect the full amount of funded and unfunded accrued benefits for defined benefit interests. According to the ATO, this will be the amount by which the “defined benefit contributions” for the interest (generally, as calculated for the purposes of Division 293 tax: ¶4-225) exceed the “notional taxed contributions” for the interest. Law Companion Ruling LCR 2016/11 contains seven examples to illustrate the ATO’s view. Basic concessional contributions cap may be increased by catch-up contributions Individuals who do not fully use their concessional contributions cap from the 2018/19 financial year onwards may be able to make catch-up contributions in later years. The purpose of allowing catch-up contributions is to benefit people whose ability to make regular superannuation contributions is limited by interrupted work patterns or irregular income. Individuals with a total superannuation balance (¶4-233) of less than $500,000 just before the start of a financial year may be able to increase their concessional contributions cap in the financial year by applying unused concessional contributions cap amounts from one or more of the previous five financial years. The $500,000 threshold amount is not indexed. An individual would have unused concessional cap amounts for a financial year if they did not fully use their basic concessional contributions cap for that year. Only unused amounts accrued from the 2018/19 financial year onwards may be carried forward. This means the 2019/20 financial year is the first year in which unused concessional contributions cap amounts can be applied. Unused amounts not utilised after five years cannot be carried forward. An individual’s concessional contributions cap cannot be increased by more than the amount by which they would otherwise exceed the concessional contributions cap. Only the exact amount of unused concessional contributions cap that is necessary is used, and any remaining unapplied unused concessional contributions cap is preserved to be carried forward for another year. Example In the 2023/24 financial year, Saul has $45,000 concessional contributions, comprising a deductible personal contribution of $28,000 and his employer’s contribution of $17,000 on his behalf. At 30 June 2023, Saul’s total superannuation balance is less than $500,000. Assuming that the basic concessional contributions cap is $25,000 for 2023/24, Saul will have exceeded the cap by $20,000 in that year. For the previous five years, he has unused concessional contributions cap amounts of $15,000. Saul will be able to increase his concessional contributions cap for 2023/24 by using $15,000 of unused concessional contributions cap from the previous five years. The remaining $5,000 of unapplied concessional contributions cap is carried forward for a later year.

Amounts of unused concessional contributions cap are applied in order from the earliest to the most

recent year. Amounts not used after five financial years can no longer be carried forward.

¶4-235 Penalties imposed on excess concessional contributions Excess concessional contributions (¶4-234) are included in a member’s assessable income and are taxed at marginal rates. Excess concessional contributions charge is also imposed on the excess contributions. In the absence of the penalties, concessional contributions would be taxed at 15% when paid into a complying superannuation fund and the benefit attributable to those contributions would be tax-free if later paid as a superannuation benefit to a member aged at least 60. Penalties on excess concessional contributions may be avoided if, on application by the member, the Commissioner makes a determination to disregard contributions or to reallocate them to another year (¶4250). Treatment of excess concessional contributions From 2013/14, excess concessional contributions are treated as follows. 1. Included in assessable income and taxed at ordinary tax rates Excess concessional contributions, ie concessional contributions in excess of the relevant concessional contributions cap (¶4-234) for the year, are included in an individual’s assessable income and taxed at ordinary tax rates (¶1-055). The Commissioner retains discretion to disregard or reallocate excess concessional contributions to another year upon the application of an individual (¶4-250). 2. Offset of 15% of the excess contributions An individual is entitled to a non-refundable offset equal to 15% of their excess concessional contributions. This offset reduces the individual’s tax liabilities to account for the tax payable on the contributions when they are paid to the superannuation fund. If the amount of the offset is greater than the tax liability, the excess amount of the offset is lost. Example For the 2020/21 financial year, Chris, who is aged 43 and runs his own business, claims a $40,000 deduction for the contributions he makes to his superannuation fund. Because Chris’ concessional contributions cap is $25,000, he has excess concessional contributions of $15,000. The tax consequences for Chris are as follows: – the $15,000 excess concessional contributions are included in Chris’ assessable income and taxed at his marginal tax rate – he is entitled to a tax offset equal to 15% of the excess concessional contributions, ie a tax offset of $2,250 ($15,000 × 15%), and – the offset is applied to reduce the income tax liability on Chris’ income for the year.

3. Imposition of excess concessional contributions charge Excess concessional contributions charge is payable on the amount of an individual’s income tax liability for an income year that is attributable to the individual having excess concessional contributions. The calculation of the charge takes into account both the increase in the individual’s income tax liability due to the inclusion of their excess concessional contributions and the reduction in their tax liability due to the tax offset. The charge is payable from the first day of the income year in which the excess concessional contributions are made to the day before the tax is due to be paid under the individual’s first income tax assessment for the year that includes the excess concessional contributions. The excess concessional contributions charge for a day is worked out by multiplying the rate worked out under s 4 of the Superannuation (Excess Concessional Contributions Charge) Act 2013 for that day by the sum of: (i) the amount of tax on which the individual is liable to pay the charge, and

(ii) the excess concessional contributions charge on that amount from previous days. The formula for calculating the charge uses a base interest rate for the day plus an uplift factor of 3%. The base interest rate is the monthly average yield of 90-day Bank Accepted Bills published by the Reserve Bank of Australia. Excess concessional contributions charge is calculated daily and compounds daily. The charge is not deductible (ITAA97 s 26-74) and the Commissioner does not have discretion to remit it. Example In 2020/21, Sanjay has excess concessional contributions of $5,000 and, when this amount is included in his assessable income, his taxable income is $70,000. Sanjay’s marginal tax rate is 32.5% and he is also liable for Medicare levy of 2%. As a result of the excess concessional contributions, Sanjay’s taxable income has increased by $5,000, and his additional tax liability is $1,725 ($5,000 × 34.5%). Sanjay is entitled to a tax offset equal to 15% of his excess concessional contributions, decreasing his tax liability by $750. The amount of Sanjay’s income tax liability that is attributable to his excess concessional contributions is $975 ($1,725 − $750). The calculation of the charge is based on this amount.

4. Release of excess contributions An individual may elect to have up to 85% of their excess concessional contributions for a financial year released from superannuation. There is an 85% cap because the remaining 15% represents the income tax liability that the fund incurred when it received the contributions. The choice of how much to release, up to the 85% limit, is at the discretion of the individual. No tax is payable on the released amount. Once the Commissioner receives an individual’s election to release an amount, the Commissioner must provide a release authority for the specified amount to the relevant superannuation fund. A superannuation fund may choose not to comply with the release authority if the individual has a defined benefit interest, an interest in a non-complying fund or an interest that supports a superannuation income stream. 5. Impact on the amount of an individual’s non-concessional contributions An individual’s excess concessional contributions are included in the calculation of their non-concessional contributions, which is significant in determining whether the individual has excess non-concessional contributions (¶4-240). If an individual elects to release an amount of their excess concessional contributions, the amount of their excess concessional contributions that is counted is reduced for the purpose of determining their non-concessional contributions. The amount of the reduction is equal to 100/85 of the amount released. As a result, if an individual chooses to release the full 85% of their excess concessional contributions, their excess concessional contributions will have no impact on their nonconcessional contributions. Excess concessional contributions tax before 2013/14 For 2012/13 and earlier years, excess concessional contributions tax was payable by an individual on their excess concessional contributions. If the Commissioner determined that an individual had excess concessional contributions, the Commissioner sent to the individual: (i) an excess concessional contributions tax assessment, and (ii) a release authority to enable the individual to withdraw the amount of the excess concessional contributions tax from their superannuation fund. The release authority allowed the individual to withdraw excess contributions and use them to satisfy the tax liability. Excess concessional contributions were also included in an individual’s non-concessional contributions (¶4-240), which could have the effect of the individual being liable to excess non-concessional contributions tax (¶4-245).

¶4-240 Excess non-concessional contributions An individual has excess non-concessional contributions for a year if the amount of their nonconcessional contributions for the year exceeds their non-concessional contributions cap. For an individual with excess non-concessional contributions, the consequence may be either: • an election by the individual to withdraw the excess contributions and earnings on those contributions, and to pay tax on those earnings, or • a liability to excess non-concessional contributions tax. The tax treatment of excess non-concessional contributions is discussed at ¶4-245. Non-concessional contributions cap As a general rule, the non-concessional contributions cap is $100,000 for 2020/21, the same as for the previous three years. The cap was $180,000 for the years 2014/15 to 2016/17. The non-concessional contributions cap is indexed in increments of $2,500 in line with average weekly ordinary time earnings. From 2017/18, the non-concessional contributions cap is nil for an individual who, immediately before the start of the year, had a total superannuation balance (¶4-233) that equals or exceeds the $1.6m general transfer balance cap (¶4-229) for the year. Such individuals are not allowed to make non-concessional contributions for the year. Bringing forward non-concessional contributions Despite the actual amount of the non-concessional contributions cap for a year, an individual aged under 65 may be able to use three years’ worth of non-concessional contributions in one year. Individuals who are aged 63 or 64 in a particular year and who fully take advantage of the bringing forward of contributions for the next two years are not required to meet the work test (¶4-205) in either of those two following years. From 2017/18, an individual is eligible to bring forward contributions in a particular financial year if: • their non-concessional contributions for that year exceed their general non-concessional contributions cap • their total superannuation balance (¶4-233) is less than the general transfer balance cap (¶4-227) ($1.6m for 2020/21, 2019/20, 2018/19 and 2017/18) • the difference between the general transfer balance cap and their total superannuation balance is greater than the general non-concessional contributions cap • they are under 65 years at any time in the year, and • a bring forward period is not currently in operation for them in respect of the year. For 2020/21 and the previous three financial years, the amount of the cap an individual may bring forward is: (a) three times the annual cap, ie $300,000, over three years if their total superannuation balance is less than $1.4m (b) two times the annual cap, ie $200,000, over two years if their total superannuation balance is above $1.4m and less than $1.5m, and (c) nil if their total superannuation balance is $1.5m or above, ie there is no bring forward period and the general non-concessional contributions cap applies. An individual cannot make a non-concessional contribution at all if their total superannuation balance at

30 June before the year commences is $1.6m or more. Transitional arrangements apply to individuals who brought forward their non-concessional contributions cap in the 2015/16 or 2016/17 financial years. These rules ensure the benefit of the $180,000 pre2017/18 cap is not retained for any part of the bring forward period that occurs in later years. Example If an individual triggered their bring forward period in the 2015/16 financial year, their non-concessional contributions cap for the first (2015/16) and second (2016/17) years are set by the rules that applied to those years, ie based on $180,000. Their cap for the 2017/18 year is applied as if the first year cap had been $460,000 (ie $180,000 for 2015/16, $180,000 for 2016/17 and $100,000 for 2017/18). The individual is entitled to contribute $460,000 over the bring forward period. If, however, an individual triggered their bring forward period in the 2016/17 financial year, their non-concessional contributions cap for the first (2016/17) year is set by the rules that applied to that year, ie based on $180,000. Their cap for the second (2017/18) and third (2018/19) years is applied as if the first year cap had been $380,000 (ie $180,000 for 2016/17, $100,000 for 2017/18 and $100,000 for 2018/19).

The government announced in the 2019 Federal Budget that individuals aged 65 and 66 whose nonconcessional contributions exceed $100,000 from 1 July 2020 may be eligible to access the bring forward arrangements. This proposal is being implemented by the Treasury Laws Amendment (More Flexible Superannuation) Bill 2020, which was introduced into Parliament on 13 May 2020. Non-concessional contributions Non-concessional contributions are generally contributions made in a year by an individual that are not included in the assessable income of a superannuation fund. In most cases, these are undeducted contributions from after-tax income. Contributions made directly by an individual into their spouse’s account (¶4-250) are counted against the receiving spouse’s non-concessional contributions cap, and not against that of the contributor. Excess concessional contributions (¶4-234) may also be counted as non-concessional contributions. From 2013/14, where an individual elects to have excess concessional contributions released from superannuation (¶4-235), the released amount is not counted as non-concessional contributions. Amounts that are not included in non-concessional contributions Non-concessional contributions generally do not include: • a government co-contribution • a payment relating to a structured settlement or orders for personal injuries • contributions to a constitutionally protected fund (usually for state government employees), or • an amount rolled over from one complying superannuation fund to another or paid from a complying superannuation fund to an entity to purchase a superannuation annuity. Contributions of amounts that come from the disposal of small business assets may also not be included in a person’s non-concessional contributions. The amount that is not included is contributions up to the “CGT cap amount”. This is a lifetime, not annual, cap. The CGT cap amount, which is $1.565m for 2020/21 ($1.515m for 2019/20 and $1.480m for 2018/19), may include: • capital gains on assets that the taxpayer has held for at least 15 years • capital proceeds from the disposal of assets that would otherwise have qualified for the CGT exemption except that the disposal of the assets resulted in no capital gain, the asset was a pre-CGT asset, or the asset was disposed of within 15 years because of the permanent incapacity of the person, and • up to $500,000 of capital gains arising from the sale of a small business and placed in a complying superannuation fund so it can be used for retirement.

¶4-245 Tax treatment of excess non-concessional contributions For 2020/21 (and the previous seven years), two possible tax treatments apply where an individual has excess non-concessional contributions (¶4-240) for a year: • the individual can elect to withdraw excess non-concessional contributions plus 85% of the associated earnings on the excess contributions and tax is payable on the associated earnings, or • the individual is liable to pay excess non-concessional contributions tax on the excess contributions. Election to withdraw excess non-concessional contributions In order to avoid liability to excess non-concessional contributions tax, an individual can elect to withdraw excess non-concessional contributions made on or after 1 July 2013 plus 85% of the associated earnings on the excess contributions. The full amount of the associated earnings is taxed at the individual’s marginal tax rate, but the individual is entitled to a non-refundable tax offset equal to 15% of the associated earnings that are included in their assessable income. Excess non-concessional contributions tax is not imposed on excess non-concessional contributions if they are withdrawn from the superannuation fund, but may be imposed on any excess contributions that remain in the fund. The “associated earnings” amount is intended to approximate the amount earned from the excess contributions while they were held in superannuation. The amount is calculated for the period that: • starts on the first day of the year the excess contributions were made, and • ends on the day the Commissioner makes a determination that the individual has excess nonconcessional contributions for the year. The amount is calculated using an average of the general interest charge rate for each of the quarters of the contributions year and compounds on a daily basis. If an individual elects to release their excess non-concessional contributions plus 85% of the associated earnings, the Commissioner must issue a release authority to a superannuation fund identified in the election. The superannuation fund that receives the release authority has 21 days to pay to the individual the lesser of the amount stated in the release authority and the maximum amount that can be released from interests it holds for the individual. The tax consequences of the individual’s election are: • the excess non-concessional contributions that are paid to the individual are received as a tax-free superannuation lump sum benefit • the associated earnings amount is included in the individual’s assessable income and taxed at the individual’s marginal tax rate for the year the excess contributions were made, and • the individual is entitled to a non-refundable tax offset equal to 15% of the associated earnings amount included in their assessable income. The ATO is monitoring (search: Super Scheme Smart: Individuals) schemes where individuals (including SMSF members) seek refunds of deliberately excess non-concessional contributions with a view to manipulating the taxable and non-taxable components of their superannuation account balances. Liability to excess non-concessional contributions tax Excess non-concessional contributions tax may be payable by an individual who has excess nonconcessional contributions in a year. The tax is payable on the excess contributions at the rate of 47% for 2020/21 (and the previous three years). If the excess non-concessional contributions were made on or after 1 July 2013, excess non-concessional contributions tax is not imposed to the extent that the individual chooses to withdraw the excess contributions plus 85% of associated earnings from superannuation (see “Election to withdraw excess non-concessional contributions” above).

If, based on superannuation fund and tax return information, the Commissioner determines that an individual has excess non-concessional contributions for a year, the Commissioner will: • make an assessment of the individual’s excess non-concessional contributions tax liability, and • send to the individual an excess non-concessional contributions tax assessment and a release authority. The release authority authorises the fund, according to the individual’s direction, to pay either the individual or the ATO an amount up to the amount stated in the authority. The authority allows an individual to withdraw superannuation money which would otherwise be preserved in the fund until the individual has reached preservation age or has retired (¶4-400). The individual must, within 21 days, give the release authority to a fund that holds a superannuation interest for the person (other than a defined benefit interest). As long as the release authority is given to the superannuation fund as required, the fund must comply with the request for the release of funds within 30 days. If payment is made to the ATO, it is taken to satisfy the individual’s liability for excess nonconcessional contributions tax. If payment is made to the individual, it is tax-free to the extent that it does not exceed the amount authorised for release, with any excess amounts being assessed at marginal rates. In some circumstances, the ATO may send the release authority directly to the superannuation fund.

¶4-250 Excess contributions may be disregarded or reallocated to another year In limited circumstances, the Commissioner may make a determination that excess concessional contributions (¶4-234) or excess non-concessional contributions (

¶4-240) are to be disregarded or reallocated to another year. Such a determination would reduce the adverse consequences that follow from excess contributions being made for an individual (¶4-235 and ¶4245). Generally, the Commissioner can only make a determination after an individual has made an application for the determination to be made. As an exception, a determination may be made after the Commissioner has made contributions to a fund on behalf of the individual, and the contributions represent amounts recovered from the individual’s employer under the SG amnesty (¶4-560). Circumstances in which the Commissioner may make a determination The Commissioner may only make a determination to disregard contributions or to allocate them to another year if it is considered that: • to make the determination would be consistent with the object of the legislation, which is stated to be to ensure that the amount of concessionally taxed superannuation benefits an individual receives results from contributions that have been made gradually over the course of the individual’s life, and • there are “special circumstances”. In making the determination, the Commissioner may have regard to: • whether a contribution would more appropriately be allocated to another year, eg if the employer should have made the contribution in a different year but failed to do so, and • whether it was reasonably foreseeable, when the contribution was made, that the member would have excess contributions for the relevant year. Special circumstances Circumstances would be “special” if their existence would make it unjust, unreasonable or inappropriate for excess contributions tax to be imposed, and if they are different from the ordinary or usual. Example George is aged 45. His employer contributes $20,000 each year to his superannuation fund under the terms of an effective salary sacrifice arrangement. However, his employer’s contribution for Year 1 is made on 3 July of Year 2 and the contribution for Year 2 is made on 29 June of Year 2. This results in George having no concessional contributions for Year 1 but $40,000 concessional contributions in Year 2. The Commissioner may exercise his discretion to allocate $20,000 to Year 1. This reallocation would fairly match the employer’s contributions to the financial year in which they should have been made.

Special circumstances would not include: • financial hardship • ignorance of the law • incorrect professional advice, or • retrospectivity of the law or an adverse effect from legislative changes (Practice Statement Law Administration PS LA 2008/1). If the Commissioner refuses to make a determination to disregard or reallocate contributions, the affected taxpayer may apply to the Administrative Appeals Tribunal (AAT) for review of the Commissioner’s decision. It has been difficult for taxpayers to prove that there are sufficiently special circumstances for the Commissioner to exercise the discretion to disregard or allocate a contribution to another year. For example, taxpayers were unsuccessful in: • Schuurmans-Stekhoven v FC of T 12 ESL 03, where an employer made contributions for an employee in early July 2007 and the employee unsuccessfully argued that the contributions should

be allocated to the 2006/07 income year • Tran v FC of T 2012 ATC ¶10-236, where a taxpayer who made excess non-concessional contributions alleged that the error resulted from incorrect information issued by the ATO • Peaker v FC of T 2012 ATC ¶10-238, where a cheque mailed to a superannuation fund on 28 June 2007 by the taxpayer’s employer was received by the fund on 5 July 2007 and was counted towards the taxpayer’s concessional contributions cap for 2007/08 (rather than, as the taxpayer expected, for 2006/07), and • Paget 2012 ATC ¶10-251, where an employer initiated an electronic funds transfer to the taxpayer’s superannuation fund on 30 June 2009, but the contribution was not received into the fund’s bank account until 1 July 2009, resulting in the taxpayer being liable to excess contributions tax for 2009/10. Hamad 2012 ATC ¶10-280 is one of the few cases where a taxpayer has successfully argued that special circumstances meant the Commissioner should have made a determination in the taxpayer’s favour. The employer usually made contributions in the month following the sacrifice of salary. However, for April, May and June 2009 a single contribution was made in July 2009. This meant that the taxpayer had 15 months of contributions made for him in 2009/10, and became liable to excess contributions tax. The AAT said the employer contributions received in July 2009 should be allocated to 2008/09 because there were special circumstances in that the taxpayer had been misled by his employer who retained superannuation amounts and made late payments.

¶4-260 Splitting superannuation contributions with a spouse Contributions to a superannuation fund may be split with the member’s spouse. Splitting is available whether the contribution is made by the member personally or by the member’s employer on behalf of the member. Contributions splitting can be used with other planning strategies such as spouse contributions, salary sacrifice and government co-contributions. This particularly assists couples where there is a significant disparity between the incomes of the two spouses. The low income or non-working spouse gains superannuation assets, receives tax concessions and has their own income in retirement. Moving superannuation into the account of the older spouse can be beneficial because that spouse may be able to satisfy a condition of release sooner and, if they are 60 or older, will be taxed on the benefit at a lower rate than the younger spouse would be. Placing the superannuation assets in the account of one spouse rather than the other may also be beneficial when the assets test or income test is being applied for social security purposes (¶6-500). Contributions splitting does not, however, enable a member with excess concessional contributions to avoid penalties on the excess contributions (¶4-235) because the contributions have already been included in the assessable income of the fund before they are split by the member. Members of a superannuation fund can split their contributions with their spouse if they are members of an accumulation fund or members of a defined benefit fund and hold an accumulation interest in the fund. Married or de facto couples (including a same-sex couple) can apply. What contributions can be split? Contributions that can be split are called “splittable contributions”. Most commonly, these are as follows: • contributions to a superannuation fund by an employer for a member • deducted contributions by a member • SG amounts transferred to a member’s superannuation account by the ATO, and • amounts allocated from a fund surplus by a trustee to meet the employer’s liability to contribute.

Amounts that cannot be split include: • existing superannuation benefits in the fund • undeducted contributions by a member • amounts rolled over or transferred into the fund, and • capital gains tax exempt amounts arising from the disposal of a small business and used for retirement. How does contributions splitting work? Contributions splitting allows a member to make a request to the trustee of their fund after the end of a financial year relating to splittable contributions made in the previous financial year. Example Adonis Imports makes four quarterly SG contributions on behalf of Jess during 2020/21. After 30 June 2021, Jess can apply to the fund trustee for the contributions to be split with her spouse.

A member can also apply to have splittable contributions made in the current financial year split if the member’s entire superannuation benefit is to be rolled over or transferred in that year. Limit on contributions that can be split A member can only split contributions up to the maximum limit for the year. The maximum amount that can be split is 85% of the taxed splittable contributions, ie employer contributions and deductible personal contributions. The 85% limit ensures that it is the amount of the taxed splittable contributions, net of 15% contributions tax, that can be split. Application to split contributions A member with an accumulation interest in a fund may apply to the trustee to roll-over, transfer or allot an amount for the benefit of the member’s spouse. A trustee does not have to accept a member’s application, but if it is accepted the trustee must act on it within 90 days. A trustee cannot act on an invalid application. An application is invalid if: • in the financial year in which it is made, the member has already made an application that the trustee has acted on or is still processing • the application relates to benefits exceeding the maximum splittable amount, or • the member’s spouse is too old — generally, this means that the spouse is aged 65 years or more, or is aged between the relevant preservation age (¶4-400) and 65 years and is permanently retired from the workforce. Although trustees are not required to accept a splitting application, they may do so if they are satisfied that all conditions for a valid application have been met. In addition to those conditions, trustees may impose additional restrictions before accepting a splitting application. Consequences of contributions splitting The splitting of a member’s contributions has the following consequences: • a new superannuation benefit is created for the spouse — this benefit is treated as a roll-over if rolled over to another fund or if transferred to an account in the existing fund in the spouse’s name, and is not treated as a contribution to the spouse’s fund • the new superannuation benefit consists entirely of a taxable component, and there is no tax-free component

• the taxable component consists of an element taxed in the fund if paid from a member’s account in a taxed superannuation fund; the amount of the taxed element cannot exceed the amount of the taxed splittable contributions specified in the member’s contributions splitting application, and the taxable component otherwise consists of an element untaxed in the fund, and • amounts credited to the spouse’s account are preserved benefits until the trustee is satisfied that they are no longer preserved benefits, eg on the member reaching preservation age and permanently retiring, reaching age 65 or becoming permanently incapacitated.

¶4-265 Government co-contribution for low income earners An individual may be entitled to a government co-contribution to match their undeducted personal contributions. To be eligible for the co-contribution, a taxpayer must satisfy the following conditions. 1. The taxpayer makes personal contributions to a complying superannuation fund for the purpose of obtaining superannuation benefits. 2. At least 10% of the taxpayer’s total income for the year comes from employment-related activities (ie work as an employee, including being deemed to be an employee for SG purposes (¶4-520)) or from carrying on business. A person’s “total income” is the sum of their assessable income, reportable fringe benefits (fringe benefits reported on the person’s payment summary) and RESCs, most commonly, salary sacrificed into superannuation. RESCs are discussed at ¶4-215. 3. The taxpayer’s total income for the year is less than the higher income threshold which, for 2020/21 is $54,837 ($53,564 for 2019/20). For a person deriving income from carrying on business, business deductions (but not deductions for personal superannuation contributions) are taken into account in calculating their total income. Excess contributions that are included in a taxpayer’s assessable income (¶4-235 and ¶4-245) are not included in the taxpayer’s total income for this purpose. 4. The taxpayer lodges an income tax return for the year. 5. The taxpayer’s non-concessional contributions (¶4-240) for the year do not exceed their nonconcessional contributions cap ($100,000 for 2020/21 and the previous three years) for the year. 6. Immediately before the start of the financial year, the taxpayer’s total superannuation balance (¶4233) is less than the general transfer balance cap (¶4-227) for the year, ie $1.6m for 2020/21 (and the previous three years). 7. The taxpayer is aged less than 71 years at the end of the year. 8. The taxpayer does not hold an eligible temporary resident visa at any time during the year. No co-contribution for deducted contributions A contribution is only eligible to be matched by a government co-contribution to the extent that the Commissioner has not allowed a deduction for the contribution. Example Rohit carries on a freelance sign writing business and is entitled to claim deductions for contributions he makes to a complying superannuation fund. During 2020/21, his total income (after taking account of business-related expenses) is $31,000. If he contributes $10,000 to a superannuation fund and claims a deduction for only $9,000, he would be entitled to a government cocontribution for the $1,000 undeducted contribution, which would be of more value to him than if he claimed a deduction for the $10,000.

Where deductible contributions have been made by a taxpayer, or are made on the taxpayer’s behalf by an employer, a low income superannuation tax offset (¶4-270) may be allowable.

Calculation of co-contribution The maximum government co-contribution for 2020/21 and 2019/20 is 50% of the eligible contributions the person makes during the income year, up to a maximum co-contribution of $500. The actual amount of co-contribution to which an employee is entitled varies according to the income of the employee for the year. For 2020/21, for a personal contribution of $1,000, the maximum co-contribution is: • if the sum of the person’s total income for the year is $39,837 or less — $500 • if the person’s total income for the year exceeds $39,837 — $500 reduced by 3.333 cents for each dollar by which the person’s total income for the year exceeds $39,837. A person’s entitlement to a co-contribution for 2020/21 is phased-out completely when their total income reaches $54,837. If a person contributes less than $1,000 in the year, a proportion of the maximum co-contribution may be payable. Where the contributor earns income from business rather than from employment, for the purpose of calculating the amount of the co-contribution entitlement (but not in calculating eligibility), the person’s total income is reduced by amounts for which business deductions are allowed. Example Lucy, an employee with assessable income of $40,000 and RESCs of $4,000, contributes $3,000 to a complying superannuation fund in 2020/21. As $44,000 exceeds $39,837 by $4,163, the amount of co-contribution that may be payable to Lucy for the year is calculated as the lesser of: • $500 − [$4,163 × 0.0333 = $139] = $361, and • $3,000 × 50% = $1,500 Lucy is therefore eligible for a co-contribution of $361.

Statement by superannuation fund The superannuation fund is required to make a statement to the ATO (generally by 31 October following the end of the year) indicating the amount of contributions made during the year by or on behalf of the employee. Once the ATO has received all necessary information (ie the tax return and the fund statement), the cocontribution should be paid within 60 days, generally into the fund that received the personal contributions. Interest is payable by the ATO if payment is not made by the due date. Example Mitch earns $19,000 assessable income during an income year and also has $6,000 reported on his payment summary as a reportable fringe benefit. Mitch’s employer contributes $1,500 to an industry superannuation fund on behalf of Mitch. Mitch also makes a personal contribution of $750. Mitch lodges his income tax return, and the superannuation fund makes a statement to the ATO that Mitch has received employer superannuation support and has also contributed $750. The ATO will make a determination that Mitch is entitled to receive a co-contribution, and this will be paid into Mitch’s superannuation fund.

¶4-270 Low income superannuation tax offset Individuals with an adjusted taxable income below $37,000 may be entitled to a low income superannuation tax offset. The offset is capped at $500 per annum, and is intended to compensate low income individuals for the 15% tax on concessional contributions made on their behalf by their employer or by themselves. The low income superannuation tax offset replaced the low income superannuation contribution from 1

July 2017. The eligibility conditions and the amounts payable are the same for the tax offset and the contribution. Eligibility conditions An individual is only entitled to the low income superannuation tax offset if they satisfy the following conditions. • A concessional contribution (¶4-234), including an allocation from reserves and notional taxed contributions, is made for the individual. This would most commonly be an employer SG or award contribution, an employer contribution made after an employee enters into a salary sacrifice arrangement, or a personal contribution for which the individual claims a deduction. • The individual’s adjusted taxable income does not exceed $37,000. Adjusted taxable income is the sum of the individual’s: – taxable income – total adjusted fringe benefits (ie the taxable value of fringe benefits provided to the individual during the FBT year) – foreign income that is not taxable in Australia – total net investment losses (ie the amount by which deductions attributable to financial investments and rental property exceed the gross income from financial investments and rental property) – tax-free pensions and benefits (not including superannuation income stream benefits that are tax-free for an individual aged at least 60), and – reportable superannuation contributions (ie deductible superannuation contributions made for the individual in the year by an employer or by the individual, including salary sacrifice contributions), less the child support or child maintenance expenditure for the year. • At least 10% of the individual’s total income for the year is derived from employment-related activities or from carrying on a business. Excess concessional contributions that are included in the individual’s assessable income (¶4-235) are disregarded in calculating an individual’s total income. • The individual is not a holder of a temporary resident visa. Amount of the low income superannuation tax offset The maximum amount of low income superannuation tax offset for an individual for a year is calculated generally as 15% of the individual’s concessional contributions up to a maximum of $500. Example A self-employed individual with adjusted taxable income of $32,000 makes deductible superannuation contributions of $15,000 in 2020/21. The low income superannuation tax offset is calculated as:

$15,000 × 15% = $2,250. As this amount exceeds $500, the allowable tax offset is $500.

A low income superannuation tax offset is not included in the assessable income of the superannuation fund to which it is paid, and forms part of the tax-free component when it is included in a superannuation benefit paid to the individual.

The Commissioner generally determines entitlement to the tax offset based on the member’s income tax return and other information such as the member’s payment summary or Centrelink reports. The Commissioner may estimate a member’s eligibility if, after 12 months following the relevant income year, the Commissioner reasonably believes there is insufficient information to decide whether to make a determination that a tax offset is payable. This could be, for example, because the member’s taxable income is below $18,200 and the member is not required to lodge an income tax return.

¶4-275 Tax offset for spouse contributions A taxpayer may be entitled to a tax offset for superannuation contributions made for the benefit of a low income or non-working spouse. Conditions that must be satisfied A taxpayer is only entitled to a tax offset for spouse contributions if the following conditions are satisfied. • The taxpayer makes a contribution to a complying superannuation fund on behalf of their spouse. “Spouse” means a legal or de facto spouse, including a same-sex spouse. A de facto spouse is one who lives with the taxpayer on a genuine domestic basis as a couple. • The taxpayer and the spouse are Australian residents when the contributions are made. • The total of the spouse’s assessable income, reportable fringe benefits and RESCs (¶4-215) is, for 2020/21 (and the previous three years), less than $40,000. • The taxpayer’s contribution is not deducted. Calculation of the offset The maximum offset in a year of income is $540, based on 18% of maximum contributions of $3,000 paid to a complying superannuation fund. For 2020/21 (and the previous three years), the $3,000 contributions limit is reduced by $1 for each $1 by which the total of the spouse’s assessable income, reportable fringe benefits and RESCs exceeds $37,000, so that the offset is fully phased-out when the total is $40,000 or more. Example Todd contributes to a complying superannuation fund for Sam, his spouse. During 2020/21, he contributes $4,000 and the total of Sam’s assessable income, reportable fringe benefits total and RESCs is $39,500. The offset to which Todd is entitled is calculated as follows: (1) determine the difference between the total of Sam’s assessable income, reportable fringe benefits total and RESCs and $37,000, ie $39,500 − $37,000 = $2,500 (2) reduce the maximum contribution amount of $3,000 by the excess at (1), ie $3,000 − $2,500 = $500 (3) the offset is 18% of the (2) amount, ie 18% × $500 = $90.

Spouses for whom contributions can be made There are no limitations on a fund accepting contributions on behalf of a spouse who is aged less than 65 years. Contributions can only be made on behalf of a spouse who is aged from 65 to 70 if the spouse is gainfully employed on at least a part-time basis (¶4-205). A fund cannot accept contributions on behalf of a spouse who has reached age 70. The following table summarises the rules for spouse contributions. Age of receiving spouse Under 65

A fund can accept contributions for a spouse under age 65, irrespective of

employment status 65–70

A fund can accept contributions for a spouse if that spouse was gainfully employed for at least 40 hours in a period of not more than 30 consecutive days in the year that the superannuation contribution was made

Over 70

A fund cannot accept contributions for a spouse aged 70 or over

Spouse contributions which qualify for the offset are not taxable contributions when received by the fund or RSA. They form part of the tax-free component when paid by the fund as part of a superannuation benefit (¶4-420). From 1 July 2020, contributions can be made for a spouse who is aged under 75, but contributions for a spouse aged between 67 and 75 can only be accepted if the spouse satisfies the work test during the year or is eligible for the one-year work test exemption (¶4-205). Before 1 July 2020, a fund could only accept contributions for a spouse aged under 70.

¶4-280 Taxation of contributions in the hands of the fund Personal contributions for which a tax deduction has been claimed and all employer contributions are included in the taxable income of a superannuation fund. The taxable income of a superannuation fund is generally taxed at 15% if it is a complying superannuation fund (¶4-320) and at 45% if it is a noncomplying superannuation fund (¶4-340). Personal contributions for which no deduction has been claimed are not included in the taxable income of the fund. This includes contributions made on behalf of a spouse (¶4-275). For 2020/21 and 2019/20, a fund must pay tax at the rate of 47% on “no-TFN contributions income”, ie contributions paid to the fund where a TFN has not been quoted (¶4-390).

TAXATION OF FUNDS AND RSA PROVIDERS ¶4-300 Taxation of funds and RSA providers A concessional tax regime applies to superannuation funds, ADFs, PSTs and RSA providers. There are three aspects to this concessional tax treatment. These relate to: • contributions paid to such entities (¶4-200 and following) • benefits paid from such entities (¶4-400 and following), and • the taxation of the entity itself. Complying superannuation funds are subject to tax on a concessional basis, with assessable income, including taxable contributions, being subject to tax at 15%. In contrast, non-complying funds are subject to a 45% tax rate. Whether or not a fund is a complying superannuation fund is determined by whether it complies with the conditions specified in SISA and SISR. The SIS regime also prescribes the conditions which other superannuation entities such as ADFs and PSTs must satisfy in order to qualify for tax concessions. Constitutionally protected funds (ie state superannuation funds) are generally exempt from tax, although some of these funds may become taxed funds. The circumstances in which a superannuation fund or ADF is complying or non-complying are discussed at ¶4-310. The tax treatment of the various superannuation entities is considered in the following paragraphs: • complying superannuation funds — ¶4-320 • non-complying superannuation funds — ¶4-340

• PSTs — ¶4-360 • RSA providers — ¶4-380. Where contributions are made to a fund and no TFN has been quoted for the individual for whom the contributions are made, the contributions are “no-TFN contributions income”, which is liable to an additional tax (¶4-390).

¶4-310 Complying or non-complying? The tax treatment of a superannuation fund depends on whether the fund is a complying or a noncomplying fund. Only a complying superannuation fund is eligible for concessional tax treatment under the income tax regime. A superannuation fund is a complying superannuation fund if APRA (or the ATO in the case of an SMSF) has given the fund a notice stating that it is a complying fund and has not subsequently given it a notice stating that it is not a complying fund. Funds other than self managed superannuation funds A fund other than an SMSF is a complying superannuation fund for a year of income if it satisfies two conditions: (1) it is a “resident regulated superannuation fund” at all times during the year of income that it is in existence (¶4-110), and (2) it does not contravene the SIS legislation, or it contravenes the SIS legislation but does not fail the “culpability test” in relation to the contravention. For a fund not to contravene the SIS legislation, the trustee must have complied with all the duties and obligations imposed on the trustees of superannuation entities, and the fund must have complied with all the conditions relevant to a resident regulated superannuation fund. An APRA-regulated fund which contravenes the SIS legislation may still qualify as a complying superannuation fund if it does not fail the culpability test in relation to the contravention. A fund fails the culpability test if: • all members of the fund were directly or indirectly knowingly concerned in, or party to, the contravention, or some (but not all) members were involved and the “innocent members” would not suffer “any substantial financial detriment” if the fund became non-complying, and • after considering the taxation consequences if the fund became non-complying, the seriousness of the contravention and all other relevant matters, APRA believes that a notice should be given to the fund stating that it is not a complying superannuation fund. Self managed superannuation funds For an SMSF (¶4-110) to be a complying fund: • the trustee must not have contravened the SIS legislation in that year, or • the trustee contravened the SIS legislation but the ATO has nonetheless decided that it should receive a compliance notice after taking into account taxation consequences, the seriousness of the contravention and any other relevant circumstances. The culpability test is not relevant for SMSFs. Non-complying funds A non-complying superannuation fund is a fund that is not a complying superannuation fund during a particular year and includes: • foreign superannuation funds

• regulated superannuation funds which contravene the SIS legislation and fail the culpability test and are not “pardoned” by the regulator, and • superannuation funds (other than exempt public sector superannuation schemes) which do not elect to become regulated superannuation funds.

¶4-320 Taxation of complying superannuation funds The taxable income of a superannuation fund (including an SMSF) is potentially made up of three components: • low tax component • non-arm’s length component, and • no-TFN contributions income. In the case of a complying superannuation fund: • the low tax component is taxed at the concessional rate of 15% • the non-arm’s length component is taxed at 45%, and • an additional tax of 32% may be imposed on the “non-TFN contributions income” (¶4-390). Assessable income The calculation of a complying superannuation fund’s assessable income takes into account that it is a resident taxpayer and is taxed on income from Australian and foreign sources. The fund’s assessable income for a year of income includes taxable contributions made to the fund for that income year, as well as taxable investment income. A fund’s taxable contributions may comprise any of the following: • employer contributions on behalf of an employee — this includes: (i) mandated and voluntary employer contributions (¶4-210), and (ii) salary sacrifice contributions (¶4-215) • deductible personal superannuation contributions (¶4-220) • amounts transferred from a foreign fund to an Australian superannuation fund (¶4-650). A complying superannuation fund which has investments in the form of superannuation policies taken out with a life assurance company or registered organisation, or in the form of units in a PST, may transfer liability to tax on taxable contributions to that entity by written agreement between the superannuation fund and the transferee entity. The effect of the transfer is that the relevant contributions are excluded from the fund’s assessable income for the year concerned, and are included in the assessable income of the transferee for the same year. Capital gains Complying superannuation funds are liable for tax on capital gains realised on the disposal of assets. Since 21 September 1999 complying superannuation funds have been entitled to a one-third discount in calculating tax on capital gains if the asset was held for at least 12 months, giving an effective tax rate of 10% for capital gains in a complying superannuation fund. If the asset was purchased prior to 11.45 am EST on 21 September 1999, the taxable gain can be calculated as the capital proceeds from the asset’s disposal reduced by the asset’s (indexed) cost base, if this gives a lower amount of tax. Tax on capital gains applies to all assets, including assets acquired before 20 September 1985 (when CGT commenced), as any asset owned by a complying superannuation fund at 30 June 1988 is, for CGT purposes, taken to have been acquired by the fund on 30 June 1988. A specific exemption from CGT

applies in respect of the disposal of life assurance policies, or rights under life assurance policies, whether or not the fund is the original beneficial owner of the policy. With a few specific modifications for assets which were held at 30 June 1988, gains or losses are calculated in accordance with the normal CGT provisions (see Chapter 2). The main modification is that the cost base used is either: • the asset’s cost base as of 30 June 1988, as calculated under the normal CGT rules, or • the asset’s market value as of 30 June 1988, whichever provides the lower gain or loss. If the cost base is used, the consideration is deemed to have been given on 30 June 1988, so that indexation (if applicable) only applies from that date. Trading stock Superannuation funds cannot treat shares, units in a unit trust or land as trading stock from 11 May 2011. They must calculate any gain or loss under the CGT provisions. Investments in PSTs If a complying superannuation fund invests in PSTs, the PSTs will have paid tax at 15% so the following special tax treatment applies: • income derived and capital gains realised by the PST are not taxable to the investing fund, and • on disposal or redemption of units in a PST, any resulting gains are not taxable under the CGT provisions, and realised losses may not be offset against capital gains. Exemption for income attributable to liability to pay income stream benefits A complying superannuation fund may be entitled to an exemption (the “earnings tax exemption”) for so much of its income as is attributable to its liability to pay certain superannuation income stream benefits, eg life pensions, allocated pensions and market-linked pensions. The earnings tax exemption does not extend to assessable contributions or to non-arm’s length income of the fund, but may be available for the capital gain on the disposal of assets. From 1 July 2017, the earnings tax exemption applies when a superannuation income stream is “in the retirement phase” (¶4-228) at the time. A superannuation income stream is in the retirement phase at a time if: (a) a superannuation income stream benefit is payable from it at that time (b) it is a deferred superannuation income stream: (i) where the rules for the provision of the benefit provide for payments to start more than 12 months after the superannuation interest is acquired and to be made at least annually afterwards, and (ii) the person who will receive the benefit has satisfied a condition of release for retirement, terminal medical condition, permanent incapacity or attaining age 65, or (c) it is a TRIS (¶16-585) and the person to whom the benefit is payable has satisfied a condition of release for retirement, terminal medical condition, permanent incapacity or attaining age 65, and, except in the case of attaining age 65 where notification is not required, has notified the superannuation income stream provider that the condition has been satisfied. Before 1 July 2017, a complying superannuation fund was entitled to the earnings tax exemption relating to its liability to pay superannuation income stream benefits that were “payable at that time”. To determine the exempt amount, the trustee may: • segregate some of the fund’s assets as specifically relating to such current pension liabilities — the exempt income is then the part of the fund’s income that is derived from the segregated current pension assets, or

• base the exemption on the proportion of average value of current pension liabilities of the fund to the average value of the fund’s total superannuation liabilities. From 1 July 2017, SMSFs and small APRA funds are not able to use the segregated method to determine their earnings tax exemption for an income year if: • at a time during the income year, there is at least one superannuation interest in the fund that is in the retirement phase • just before the start of the income year, a person has a total superannuation balance (¶4-233) that exceeds $1.6m and the person is the retirement phase recipient (¶4-228) of a superannuation income stream, and • at a time during the income year, the person has a superannuation interest in the fund. According to Law Companion Ruling LCR 2016/8, this means an SMSF or a small APRA fund cannot use the segregated method from the 2017/18 income year if it has a member who has a transfer balance under the $1.6m transfer balance cap but who also has a total superannuation balance exceeding $1.6m. The assets of such funds — called “disregarded small fund assets” in the legislation — cannot be segregated assets, and the funds are required to use the proportionate method to determine their earnings tax exemption. A superannuation fund paying a pension may be required to obtain an actuarial certificate each year to claim the earnings tax exemption. Although the earnings tax exemption is generally only available if a fund has liabilities in respect of superannuation income stream benefits, the exemption may also be available if a fund would have such liabilities except that the member has died. If a member who was receiving a superannuation income stream dies, the earnings tax exemption continues until: • the member’s benefits are cashed as a lump sum, and/or • a new superannuation income stream commences (the benefits must be cashed as soon as practicable). In such a case, the exemption amount cannot be greater than it was before the member’s death although investment earnings since that date may be added. The government proposed in the 2019 Federal Budget that from 1 July 2020 funds with interests in both the accumulation and retirement phases during an income year would be allowed to choose their preferred method of calculating exempt current pension income. At the time of writing, legislation for this proposal had not yet been introduced into Parliament. General and specific deductions As a general rule, the deductibility of expenditure incurred by a complying fund is determined under the general income tax deduction rules (¶1-305), unless a specific provision applies. In Taxation Ruling TR 93/17, the ATO states that the expenses of a superannuation fund (or of an ADF or PST) which are ordinarily deductible include: • administration fees • actuarial costs • accountancy and audit fees • costs of complying with APRA guidelines (unless the cost is a capital expense) • trustee fees and premiums under an indemnity insurance policy • costs in connection with the calculation and payment of benefits to members (but not the cost of the

benefit itself) • investment adviser fees • subscriptions for membership of professional associations, and • other administrative costs incurred in managing the fund. Expenses that are incurred partly in producing assessable income and partly in gaining exempt income must be apportioned. Two apportionment methods are set out in Taxation Ruling TR 93/17, with the correct method for apportioning an expense generally depending on the particular circumstances: • if an expense has a distinct and severable part that relates to producing assessable or nonassessable income, it can be apportioned according to the ratio of those parts, and • if expenditure serves both objects indifferently, any method of apportionment is acceptable if it gives a fair and reasonable assessment of the extent the expenditure relates to producing assessable income. In relation to other types of expenditure incurred by a superannuation fund: • an expense that is deductible under ITAA97 s 25-5 for managing a fund’s tax affairs does not need to be apportioned on account of producing any non-assessable income • although costs incurred by a trustee in establishing a superannuation fund are not deductible under ITAA97 s 8-1 because they are expenses of a capital nature, they may be deductible over five years under ITAA97 s 40-880, and • costs associated with amending a trust deed are deductible revenue outgoings if the amendments simply make the administration of the fund more efficient and do not amount to a restructuring of the fund. Deduction for disability insurance premiums A fund which provides death or disability benefits may claim a deduction for the cost of providing those benefits. Premiums are only deductible to the extent the fund has a current or contingent liability to provide a “disability superannuation benefit” (ITAA97 s 295-465). For these purposes, a superannuation benefit is a disability superannuation benefit if: • it is paid to a person because he or she suffers from either physical or mental ill-health, and • two legally qualified medical practitioners have certified that, because of the ill-health, it is unlikely that the person can ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training. This means that premiums may be only partially deductible if the total and permanent disability (TPD) definition in a particular policy is broader than the ITAA97 definition of disability superannuation benefit, or if it is the same but the insurance policy includes other (non-deductible) types of cover and the TPD component of the premium is not specified. To overcome the potential difficulty in calculating the deduction in these cases, regulations may prescribe the proportion of a specified insurance policy premium to be treated as being attributable to a fund’s liability to provide disability superannuation benefits. Superannuation funds have the option of using the simpler method provided in reg 295-465.01 of the Income Tax Assessment Regulations 1997 for determining the deductible portion of TPD insurance premiums or can obtain an actuary’s certificate to apportion the premium differently. Superannuation funds that self-insure their liability to provide disability benefits may deduct the amount the fund could reasonably be expected to pay in an arm’s length transaction to obtain insurance to cover the liability, or may determine the deductible amount by using the percentages specified in the regulations.

The Commissioner’s views on the deductibility of premiums paid by complying superannuation funds for insurance policies that provide TPD cover for members are set out in Taxation Ruling TR 2012/6. Anti-detriment deduction when death benefit paid When a member of a superannuation fund dies and a death benefit is paid to the deceased member’s dependants or to the trustee of the deceased member’s estate in lump sum form, the superannuation fund may increase the death benefit payment to the amount that would have been available if the 15% contributions tax had not been imposed on taxable contributions to the fund. Before 1 July 2017, a fund that paid the increased amount was allowed an “anti-detriment deduction” for the amount of the increase. To claim the deduction, the fund was required to satisfy the ATO that the benefit of the deduction was passed on to the dependants of the deceased member through the increased death benefit. The anti-detriment deduction was removed for lump sums paid in relation to a death on or after 1 July 2017. The removal of the deduction extends to all benefits paid on or after 1 July 2017, regardless of whether the death was before or after that date. The purpose of the removal is to avoid inconsistencies and to better align the treatment of lump sum death benefits across all superannuation funds with the treatment of bequests outside of superannuation. Treatment of dividends Where a complying superannuation fund receives Australian company dividends, its income will be grossed up by any franking credit attaching to those dividends in the same manner as applies to other taxpayers (¶1-405). The fund is entitled to an offset for the full amount of the franking credits, even though its rate of tax is only 15%. The offset may be offset against tax on any income of the fund, including capital gains and taxable contributions. Any excess franking credits will be refunded. Foreign income tax offsets A superannuation fund is entitled to an offset for tax paid on foreign income up to the amount of Australian tax payable in respect of that income (¶1-575). Non-arm’s length income The non-arm’s length component of a complying superannuation fund’s taxable income for an income year is the amount of the fund’s non-arm’s length income less any deductions to the extent that they are attributable to that income. The non-arm’s length component is taxed at 45% for 2020/21 (and the previous three years). Three types of income make up a fund’s non-arm’s length income: • income derived from a scheme where the parties are not dealing at arm’s length and the amount is greater than it would have been from an arm’s length transaction • private company dividends, unless the amount is consistent with an arm’s length dealing, and • discretionary trust distributions and distributions where the fund has a fixed entitlement to trust income.

¶4-340 Taxation of non-complying funds A non-complying superannuation fund (eg a foreign superannuation fund or a superannuation fund that has received a notice from APRA stating that it is a non-complying fund) is taxed at the rate of 45% for 2020/21 (and the previous three years). A non-complying fund is not eligible for certain tax concessions available to a complying fund (¶4-320). Concessions denied to a non-complying fund include: (i) tax at the 15% rate (ii) special CGT rules, although a non-complying fund is entitled to a 50% CGT discount as a trust

(iii) death and disablement insurance deductions (iv) exemption of income related to pension liabilities (v) ability to transfer contributions tax liability (vi) ability to exclude “last minute” employer contributions from fund income (vii) the ability to invest with PSTs, and (viii) refund of excess franking credits. Other tax-related matters applying specifically to non-complying funds include the following: • neither employer nor member contributions are tax deductible • member contributions cannot be matched by a government co-contribution • a tax offset is not available when contributions are made on behalf of a spouse • employer contributions cannot satisfy the employer’s obligations under the SG scheme • a liability to tax may arise for transfers of amounts from certain superannuation funds, and • account holders in the SHASA cannot transfer their entitlements to a non-complying fund. Consequences of becoming non-complying If a complying superannuation fund becomes non-complying, the fund is subject to tax at 45% on the excess of the market value of its total assets over total undeducted contributions. This could occur, for example, if an Australian superannuation fund ceases to satisfy the conditions for being an Australian superannuation fund (¶4-600).

¶4-360 Taxation of PSTs and RSA providers Unit trusts which qualify as PSTs under the SIS legislation (¶4-120) are generally subject to tax at the rate of 15% on their taxable income. The non-arm’s length component of the taxable income of a PST is subject to tax at the rate of 45% for 2020/21 (and the previous three years). RSA providers (¶4-120) are subject to tax at the rate of 15% on the RSA component of their taxable income.

¶4-390 Tax on “no-TFN contributions income” Superannuation funds and RSA providers are taxed at the rate of 47% for 2020/21 (and the previous three years) on their “no-TFN contributions income”. The 47% rate comprises the normal tax payable on assessable contributions and an additional 32% (or 2% for non-complying funds) tax on the no-TFN contributions income. An entity’s no-TFN contributions income is the amount of superannuation contributions included in the entity’s assessable income where no TFN is “quoted (for superannuation purposes)” by the individual. A TFN is “quoted (for superannuation purposes)” if the individual quotes their TFN to the fund or is taken to quote their TFN to the fund. If an individual makes a TFN declaration to an employer who makes a superannuation contribution for the individual, the individual is taken to have authorised the employer to inform the fund of the individual’s TFN. A TFN is also quoted for these purposes to a fund if the ATO passes an individual’s TFN to the fund. A fund may be entitled to a tax offset for tax on no-TFN contributions income if the individual later quotes a TFN. The offset can only be claimed in a year after the year tax is paid on the no-TFN contributions income and is only available if the tax was payable in one of the three most recent years before the TFN

is quoted. The amount of the offset is the tax payable on the no-TFN contributions income in the three most recent income years. An amount is exempted from the no-TFN contributions income rules if: • the superannuation interest to which the contribution relates existed before 1 July 2007, and • contributions relating to the superannuation interest for the year that are included in assessable income do not exceed $1,000.

WITHDRAWAL OF SUPERANNUATION BENEFITS ¶4-400 Withdrawal of superannuation benefits The objective of superannuation, and the justification for the tax concessions attached to superannuation, is that money is put aside by individuals so that they can support themselves in their retirement and not be dependent on the age pension. As a general rule, superannuation money is preserved in a fund until a person retires from employment. The government proposes that this objective will be enshrined in legislation (¶4-100). There are two types of superannuation benefits: • a superannuation member benefit paid to a fund member (¶4-420), and • a superannuation death benefit paid to another person after a fund member dies (¶4-425). Generally, a superannuation benefit can be paid as a lump or as an income stream, although a superannuation death benefit must be paid as a lump sum unless it is being paid to a dependant. Preservation rules may prevent withdrawal of benefit Benefits that accrue to a member in a fund are classified in one of three ways: as preserved benefits, restricted non-preserved benefits or unrestricted non-preserved benefits. Preserved benefits can only be paid if the member satisfies a condition of release, meaning the member: • retires from employment and has reached preservation age (see the table below) • terminates employment on or after age 60, irrespective of future work intentions • dies • is permanently incapacitated • suffers severe financial hardship • reaches age 65 • qualifies on compassionate grounds, eg medical treatment needs to be paid for • receives a non-commutable income stream during a period of temporary incapacity • has reached preservation age and takes the benefits as a non-commutable income stream • is a former temporary resident who has departed from Australia • transfers their superannuation to a New Zealand KiwiSaver scheme • suffers from a terminal illness, or • has given a release authority to the fund for amounts to be released.

A special condition of release is intended to support an individual who is affected by the adverse economic effects of COVID-19. Such an individual could apply up to 30 June 2020 to have $10,000 released on compassionate grounds during the 2019/20 financial year, and another application could be made from 1 July 2020 to 31 December 2020 for a further $10,000 to be released during the 2020/21 financial year. An amount released on compassionate grounds relating to COVID-19 is tax free. Restricted non-preserved benefits include benefits accruing to a member in an employer superannuation scheme which accrued before 1 July 1999 and which are not preserved but are not yet payable because the member is still an employee of the employer. These benefits can be withdrawn in the same circumstances as preserved benefits but may also be withdrawn on the member terminating employment with that employer, which can be before preservation age. Unrestricted non-preserved benefits are benefits which the member could have withdrawn but which have been rolled over to another superannuation fund. These include employment termination payments that, before 1 July 2007, were allowed to be rolled into a fund rather than taken as cash. These benefits are not subject to preservation and can be withdrawn at any time. Preservation of contributions and earnings Since 1 July 1999, contributions made by or on behalf of members to a superannuation fund are preserved. Earnings on these contributions are also preserved if the fund is in an accumulation phase. If the earnings affect superannuation funds which have commenced to be paid as an income stream, the earnings are generally taken to be unrestricted non-preserved benefits. As an exception, earnings on benefits in a TRIS remain as preserved benefits until the pensioner or annuitant satisfies a condition of release with a nil cashing restriction such as retirement or reaching age 65. Once that condition of release is satisfied, the earnings become unrestricted non-preserved benefits. The amount of a member’s restricted non-preserved benefit and unrestricted non-preserved benefit as at 1 July 1999 has been “grandfathered”. These benefits retain that status but the amount does not increase, as all future contributions and earnings are preserved. Preservation age A person’s preservation age depends on when the person was born. This is shown in the following table. For a person born …

Preservation age

Before 1 July 1960

55

1 July 1960 to 30 June 1961

56

1 July 1961 to 30 June 1962

57

1 July 1962 to 30 June 1963

58

1 July 1963 to 30 June 1964

59

After 30 June 1964

60

¶4-420 Superannuation benefits paid to a member The taxation of superannuation benefits paid to a member depends on: • the age of the member • the form of the benefit (ie lump sum or income stream), and • whether the benefit is paid from an element taxed in the fund or from an element untaxed in the fund. The taxation of superannuation benefits paid on the death of a member is discussed at ¶4-425. Superannuation lump sum or superannuation income stream benefit

A superannuation benefit can be paid as either a superannuation lump sum or as a superannuation income stream benefit. A superannuation benefit is taxed as a superannuation lump sum unless it is a superannuation income stream benefit, which is basically one of a series of related payments over a period of time from a member’s superannuation. The distinction between a superannuation lump sum and a superannuation income stream benefit is significant because there are different tax consequences. In either case, the benefit may be tax-free if paid to a person aged at least 60. In other cases, a person can receive a superannuation lump sum taxfree up to the “low rate cap” amount, whereas a superannuation income stream benefit is included in assessable income and taxed at marginal rates less a 15% tax offset. Before 1 July 2017, a person to whom a payment was made from an interest supporting a superannuation income stream could, in some circumstances, elect for the payment to be treated as a superannuation lump sum benefit. These circumstances included where a superannuation income stream was partially commuted and the member elected, before the payment was made, for the payment to not be treated as a superannuation income stream benefit. Before 1 July 2017, a member could also, in certain circumstances, elect to treat a TRIS payment as a superannuation lump sum and therefore have access to tax-free amounts up to the low rate cap. Such an election cannot be made from 1 July 2017. A series of periodic payments receives concessional taxation treatment as a superannuation income stream benefit as long as the pension rules and minimum payment standards in the SISR are met. A failure to comply in an income year would technically mean the income stream would not be an “annuity” or a “pension” for the purposes of the SIS legislation and would not qualify for concessional tax treatment as a superannuation income stream benefit, eg the tax exemption for persons aged 60 or older. Instead, the income amount, minus non-deductible payments made to purchase the amount, would be included in the person’s assessable income and taxed at ordinary tax rates (ITAA36 s 27H). Superannuation benefit may have two components: a tax-free component and a taxable component A superannuation benefit may be made up of two components — a tax-free component and a taxable component. (1) Tax-free component The tax-free component of a superannuation benefit is made up of: • the “contributions segment”, which consists of contributions that are not included in the assessable income of the fund, such as undeducted member contributions and undeducted contributions made for a spouse, government co-contributions and contributions for a former temporary resident, and • the “crystallised segment”, which is basically a consolidation of the pre-1 July 2007 amount of undeducted contributions, the pre-July 83 component, the CGT exempt component, the concessional component and the post-June 1994 component — these are the components of a superannuation benefit that were taxed concessionally before 1 July 2007 and are bundled together to form an amount (which does not increase for earnings) that is part of the tax-free component. Example Heidi is paid a $96,000 superannuation lump sum benefit on 11 July 2020. The value of Heidi’s pre-July 83 component at 1 July 2007 was $33,000. She made undeducted contributions of $18,000 before 1 July 2007 and of $3,000 since that date. The tax-free component of the superannuation benefit that Heidi receives on 11 July 2020 is $54,000 made up of: – the contributions segment comprising the $3,000 undeducted contributions made from 1 July 2007, and – the crystallised segment calculated as at 1 July 2007, comprising the $33,000 pre-July 83 component and the $18,000 pre-1 July 2007 undeducted contributions. Heidi’s superannuation lump sum benefit can be divided into: – a $54,000 tax-free component, and – a $42,000 taxable component.

(2) Taxable component — comprising an element taxed in the fund and/or an element untaxed in the fund The taxable component is the amount of the member’s superannuation benefit less the tax-free component. The taxable component of a superannuation benefit may comprise an element taxed in the fund or an element untaxed in the fund or both: • the taxable component generally consists wholly of an element taxed in the fund — this means the benefit is paid from contributions that were subject to 15% tax when paid to the fund (¶4-320), or • the taxable component consists of an element untaxed in the fund if the benefit is paid from an unfunded scheme or from a superannuation scheme that is constitutionally protected from being subject to Commonwealth taxation, eg a state superannuation scheme. Taxation of member benefit paid from an element taxed in the fund The following table shows the tax treatment of a lump sum or superannuation income stream benefit paid to a member in the 2020/21 income year from an element taxed in the fund. As can be seen from the table, the tax treatment depends on the age of the member receiving the benefit. The tax-free component is non-assessable non-exempt income in all cases. Tax on taxable component of member benefit — element taxed in the fund Age

Lump sum

Income stream

Age 60 and over

Tax-free

Tax-free

Preservation age to age 59

– 0% up to the low rate cap Marginal tax rates and tax ($215,000 for 2020/21) offset of 15% of the taxable – Amount above $215,000 is component subject to tax up to maximum rate of 15%

Below preservation age

– Subject to tax up to maximum rate of 20%

Marginal tax rates (no tax offset)

Notes 1. The low rate cap was $210,000 for 2019/20 and $205,000 for 2018/19. 2. A person’s preservation age depends on when the person was born (¶4-400). 3. Medicare levy (2% of taxable income) is added where appropriate. Example Mohammad is aged 63 when he receives a superannuation lump sum benefit of $396,000 on 2 August 2020. The benefit is sourced from contributions and earnings on contributions and is paid from an element taxed in the fund. No tax is payable on the benefit.

Example Rose, who is aged 59, receives a superannuation income stream benefit of $54,000 in 2020/21. The tax-free component of the benefit is $8,000 and the taxable component is $46,000. Rose’s tax liability is calculated as follows: – the $46,000 taxable component is included in Rose’s assessable income and taxed at ordinary rates. As long as Rose has no other assessable income for the year, the tax on $46,000 is $6,314 – Rose is entitled to a tax offset equal to 15% of the $46,000 taxable component, ie an offset of $6,900 – Rose is liable to Medicare levy of $920 (2% × $46,000) – Rose has a tax liability of $334 [$6,314 initial tax − $6,900 tax offset + $920 Medicare levy].

At the start of each income year, the low rate cap may be indexed upwards from the previous year. The low rate cap amount is a lifetime limit and is reduced by any amount previously applied to the low rate threshold. Example Vera, who is aged 57, received a superannuation lump sum benefit in 2019/20 with a taxable component of $151,000. The low rate cap for 2019/20 was $210,000. No tax was payable by Vera on the $151,000 taxable component because it was below the cap for the year. In 2020/21, Vera receives a superannuation lump sum benefit with a taxable component of $88,000. Vera’s low rate cap for 2020/21 is $64,000, calculated as $215,000 (the low rate cap amount for 2020/21) minus the $151,000 applied to the cap in 2019/20. The $88,000 taxable component received by Vera in 2020/21 is taxed as follows: – no tax is payable on the amount up to Vera’s $64,000 low rate cap, and – tax is payable up to a maximum of 15% (plus Medicare levy) on the $24,000 excess over her low rate cap.

Superannuation income stream benefit from a capped defined benefit income stream Although an individual aged 60 or over is not generally liable to tax on a superannuation income stream benefit from a taxed source, an individual may be liable to tax from 1 July 2017 if the superannuation income stream benefit is “defined benefit income” (¶4-110) in excess of their “defined benefit income cap”. This rule basically applies where the superannuation income stream benefit is paid from a superannuation income stream that is subject to commutation restrictions (a “capped defined benefit income stream”). The defined benefit income cap means generally the transfer balance cap (¶4-229) for the year ($1.6m for 2020/21) divided by 16. The defined benefit income cap is therefore $100,000 for 2020/21 (the same as for the previous three years). To the extent the sum of the individual’s taxed source and tax-free income from a capped defined benefit income stream for a year exceeds the cap for the year, 50% of the excess is taxed at marginal rates. Example In the 2020/21 financial year, Sebastian receives a superannuation income stream benefit of $150,000 from his funded defined benefit scheme. The scheme is a capped defined benefit income stream because it has commutation restrictions. He has no other income for the year. Because the $150,000 benefit received by Sebastian exceeds the $100,000 defined benefit income cap for 2020/21, $25,000 (50% of the excess) is included in his assessable income and taxed at marginal rates.

This treatment is intended to complement the treatment given to defined benefit superannuation income streams that are not subject to commutation restrictions, eg account-based pensions. Such income streams are subject to the transfer balance cap rules (¶4-227) from 1 July 2017, which means the amount of an individual’s transfer balance that exceeds the $1.6m transfer balance cap must be commuted and moved to an accumulation account or be paid out. Law Companion Ruling LCR 2016/10 provides detailed examples on the tax treatment of capped defined benefit income streams. Taxation of member benefit paid from an element untaxed in the fund The following table shows the tax treatment of a lump sum or superannuation income stream benefit paid to a member in the 2020/21 income year from an element untaxed in the fund. As can be seen from the table, the tax treatment depends on the age of the member receiving the benefit. The tax-free component is non-assessable non-exempt income in all cases. Tax payable on taxable component of member benefit — element untaxed in the fund Age

Lump sum

Income stream

Age 60 and over

– Subject to tax up to a maximum Marginal tax rates and tax

of 15% on amount up to the untaxed plan cap amount of $1.565m – Top marginal rate applies to amounts above $1.565m

offset of 10% of element untaxed in the fund

Preservation age to age 59

– Subject to tax up to a maximum Marginal tax rates (no tax of 15% on amount up to the low offset) rate cap amount of $215,000 – Subject to tax up to a maximum of 30% on amount above $215,000 up to the untaxed plan cap of $1.565m – Top marginal rate applies to a amount above $1.565m

Below preservation age

– Subject to tax up to a maximum Marginal tax rates (no tax of 30% up to $1.565m offset) – Top marginal rate applies to amounts above $1.565m

Notes 1. The low rate cap was $210,000 for 2019/20. 2. The untaxed plan cap amount was $1.515m for 2019/20. 3. A person’s preservation age depends on when the person was born (¶4-400). 4. Medicare levy (2% of taxable income) is added where appropriate. Example Sabita is a 62-year-old public servant who receives a superannuation lump sum of $1,450,000 in October 2020. The lump sum comprises an element untaxed in the fund of $890,000, and a tax-free component of $560,000. The superannuation lump sum is taxed as follows: – no tax is payable on the $560,000 tax-free component – the $890,000 element untaxed in the fund is included in Sabita’s assessable income and taxed at ordinary tax rates up to a maximum of 15% – Medicare levy of 2% of taxable income is added.

Superannuation income stream benefit from a capped defined benefit income stream From 1 July 2017, the 10% tax offset for superannuation income stream benefits from an untaxed source received by an individual aged 60 or over may be limited. This will be the case if the individual receives one or more superannuation income stream benefits that are “defined benefit income” (¶4-110) in excess of their “defined benefit income cap” and are from a “capped defined benefit income stream”, basically a non-commutable superannuation income stream. The defined benefit income cap means generally the transfer balance cap (¶4-229) for the year ($1.6m for 2020/21) divided by 16. The defined benefit income cap is therefore $100,000 for 2020/21 (the same as for the previous three years). Excess untaxed source defined benefit income is not eligible for the 10% tax offset from 1 July 2017 and is assessable at the individual’s marginal rate. The excess untaxed source defined benefit income is calculated by applying the individual’s untaxed defined benefit income stream payments to any amounts remaining in their defined benefit income cap after having applied taxed source and tax-free defined benefit income.

Example In 2020/21, Hugo, aged 67, receives a $140,000 defined benefit income stream benefit, made up of $75,000 from an untaxed source and $45,000 from a taxed source, and $20,000 is a tax-free amount. The combined taxed source and tax-free amount of $65,000 is counted towards Hugo’s $100,000 defined benefit income cap, as well as $35,000 of Hugo’s untaxed source income. The remaining $40,000 of untaxed source income is denied a tax offset. Hugo’s tax offset is limited to $3,500 (10% of the $35,000 counted towards the defined benefit income cap).

This treatment is intended to complement the treatment given to defined benefit superannuation income streams that are not subject to commutation restrictions, eg account-based pensions. Such income streams are subject to the transfer balance cap rules (¶4-227) from 1 July 2017, which means the amount of an individual’s transfer balance that exceeds the transfer balance cap must be commuted and moved to an accumulation account or be paid out. Lump sum benefit paid to a member with a terminal medical condition A lump sum payment to a member with a terminal medical condition is tax-free for the member. This applies if: (i) two medical practitioners have certified that the member suffers from an illness or injury that is likely to result in the death of the member within 24 months, and (ii) at least one of the medical practitioners is a specialist practising in an area relating to the illness or injury. Benefit paid in breach of legislative requirements Special rules apply where a superannuation benefit is paid to a member in breach of legislative requirements. These rules have the effect that the benefit loses the concessional tax rates that would otherwise apply. If a benefit is paid to a member in breach of the payment standards (eg before the member satisfies a condition of release) or the fund has not been maintained as required by the legislation (eg not for the sole purpose of providing superannuation benefits for members), the benefit is included in the member’s assessable income and taxed at marginal rates. Amounts do not have to be included in a member’s assessable income to the extent that the Commissioner is satisfied that it would be unreasonable for them to be included. Penalties may be imposed on promoters of schemes that facilitate the early release of superannuation benefits. Benefits paid to former temporary resident Special rules apply if the benefit is a departing Australia superannuation payment made to a former temporary resident (¶4-435).

¶4-425 Superannuation death benefits A “superannuation death benefit” is a superannuation benefit paid to a person after another person’s death, eg a payment from a superannuation fund to a family member after an employee dies. The tax treatment of a superannuation death benefit depends on whether it is paid: • to a person who is a dependant (as defined for tax purposes) or to a person who is not a dependant of the deceased, and • as a lump sum or as an income stream. Where the trustee of a deceased estate receives a superannuation death benefit in their capacity as a trustee, it is taxed in the hands of the trustee according to whether a dependant or non-dependant is expected to benefit. Generally, only a death benefits dependant can receive a superannuation death benefit as an income

stream, ie as an annuity or pension, and, in other cases, the benefit must be paid as a lump sum. From 1 July 2017, the superannuation income stream that supports the payment of the death benefit must be “in the retirement phase”, which generally means a superannuation income stream benefit is payable from it or it is a deferred superannuation income stream or a TRIS and certain conditions have been satisfied (¶4-228). A death benefit income stream paid to an individual must be within their transfer balance cap ($1.6m for 2020/21), with excess amounts commuted or paid as a death benefit lump sum (¶4-230). Where a superannuation death benefit is paid as an annuity or pension to a child of the deceased member, it must generally be cashed as a lump sum no later than the earlier of: (a) the day the pension or annuity is commuted, or the term of the annuity or pension expires (unless the benefit is rolled over to commence a new annuity or pension), and (b) the day the child reaches 25 years. Who is a “dependant” of the deceased person for tax purposes? A “dependant” of a deceased person for tax purposes means: • a spouse or former spouse of the deceased • a child of the deceased aged under 18 years • a person who was financially dependent on the deceased just before the death, and • a person with whom the deceased had an “interdependency relationship” just before the death. A “spouse” of a deceased person means not only a person to whom the deceased was legally married but also a person who lived with the deceased on a genuine domestic basis in a relationship as a couple, and a person with whom the deceased was in a relationship that is registered under State or Territory law. Generally, two persons have an “interdependency relationship” if they satisfy the following conditions: • they live together and have a close personal relationship, and • one or each of them provides the other with financial and domestic support and personal care. Two persons are also in an interdependency relationship if they have a close personal relationship but they do not satisfy the other conditions because one or both of them suffer from a physical, intellectual or psychiatric disability or they are temporarily living apart because, for example, one is overseas. The definition of a dependant for tax purposes is different from the definition for superannuation purposes, and a superannuation fund can only directly pay a superannuation death benefit to a person who is a dependant as defined for superannuation purposes. To be a dependant of the deceased for tax purposes a child of the deceased must be under the age of 18, whereas for superannuation purposes a child of the deceased of any age can be a dependant of the deceased. This means that a financially independent child of the deceased aged over 18 can be paid a superannuation death benefit but tax will be payable on the benefit. Taxation of death benefits paid to a dependant Lump sum death benefits A lump sum death benefit is tax-free if it is paid to a dependant, and this is the case whether the benefit is paid from an element taxed in the fund or an element untaxed in the fund. Income stream death benefits The taxation of a superannuation income stream death benefit paid to a dependant depends on whether it is paid from an element taxed in the fund or an element untaxed in the fund (¶4-420). Income streams paid to a dependant from an element taxed in the fund are taxed as follows.

• the benefit is tax-free if either the deceased or the dependant was at least 60 years of age at the time of the death. • where both the dependant and the deceased were under age 60 at the time of the death: – no tax is paid on the tax-free component (¶4-420) of the income stream – the taxable component (¶4-420) is assessable income, but the dependant is entitled to a tax offset equal to 15% of the taxable component, and – no tax is payable on the income stream once the recipient turns 60. Where a child of the deceased under age 25 receives a superannuation income stream death benefit, they must commute this benefit into a lump sum when they turn 25 (unless the child has a permanent disability) and the lump sum received is tax-free. Example Martha and her sister Wanda lived together in an interdependency relationship for many years. Following Martha’s death on 3 July 2020 at the age of 58, Wanda, who was aged 57, began to receive a superannuation income stream death benefit of $35,000 a year. The $35,000 comprised an $11,000 tax-free component and $24,000 taxable component from an element taxed in the fund. The $35,000 death benefit received by Wanda is taxed as follows: – $11,000 is tax-free – $24,000 is included in Wanda’s assessable income and taxed at her ordinary rates, and – she is entitled to a $3,600 tax offset (15% of the $24,000 taxable component). The tax offset can reduce Wanda’s tax liability, including her liability to tax on other income, but any excess offset would not be refundable. If Wanda is still receiving a superannuation income stream death benefit when she reaches 60, the income stream will be tax-free.

From 1 July 2017, there is an exception to the general rule that a superannuation income stream death benefit is tax-free if either the deceased or the recipient is aged at least 60. This is where the benefit is defined benefit income that is paid from certain non-commutable superannuation income streams and exceeds the defined benefit income cap for the year ($100,000 for 2020/21). In that case, 50% of the excess is included in the taxpayer’s assessable income and taxed at marginal rates. Income streams paid to a dependant from an element untaxed in the fund are taxed as follows: • if either the deceased or the dependant was aged at least 60 at the time of death, the taxable component of the element untaxed in the fund is included in assessable income and the dependant is entitled to an offset of 10% of the element untaxed in the fund. • in other cases, the element untaxed in the fund is included in assessable income and taxed at ordinary rates. From 1 July 2017, the 10% tax offset for superannuation income stream death benefits where either the deceased or the recipient is aged at least 60 may be limited. This is where the benefit is defined benefit income that is paid from certain non-commutable superannuation income streams and exceeds the defined benefit income cap for the year ($100,000 for 2020/21). In that case, the excess defined benefit income is not entitled to the 10% tax offset and is included in the taxpayer’s assessable income and taxed at marginal rates. The following table shows the tax treatment of death benefit payments to dependants. The tax-free component is tax-free in all cases. Death benefit payments to dependants Age of deceased Any age

Type of death benefit

Age of recipient

Lump sum

Any age

Tax treatment Tax-free

Aged 60 and over

Income stream

Any age

Element taxed in the fund is generally tax-free. Element untaxed in the fund is generally taxed at marginal rates with offset of 10% of the element untaxed in the fund.

Below age 60

Income stream

Above age 60

Element taxed in the fund is tax-free. Element untaxed in the fund is taxed at marginal rates with offset of 10% of the element untaxed in the fund.

Below age 60

Income stream

Below age 60

Element taxed in the fund is taxed at marginal rates with offset equal to 15% of the amount. Element untaxed in the fund is taxed at marginal rates.

Medicare levy (2% of taxable income) is added where appropriate. Taxation of death benefits paid to a non-dependant Generally, a non-dependant cannot receive a superannuation income stream. An exception is where a non-dependant was already receiving a death benefit income stream before 1 July 2007, in which case the non-dependant is taxed as if they were a dependant. A superannuation death benefit paid as a lump sum to a non-dependant is taxed as follows: • the tax-free component is non-assessable non-exempt income, and • the taxable component is included in assessable income, with a tax offset to ensure that: (i) the rate of tax on the element taxed in the fund does not exceed 15%, and (ii) the rate of tax on the element untaxed in the fund does not exceed 30%. Example When Bill died on 3 August 2020, his superannuation was paid from an element taxed in the fund to his only child Sam who was aged 32 and lived and worked overseas. As Sam was not a dependant of Bill, the taxable component of the death benefit is included in Sam’s assessable income with a tax offset to ensure that the rate of tax on the taxable component does not exceed 15%.

The following table shows the tax treatment of death benefit payments to non-dependants. Death benefit payments to non-dependants Age of deceased

Type of death benefit

Age of recipient

Taxation treatment

Any age

Lump sum

Any age

Element taxed in the fund taxed up to a maximum rate of 15%; element untaxed in the fund taxed up to a maximum rate of 30%

Any age

Income stream

Any age

Cannot be paid as an income stream. Income streams that commenced before 1 July 2007 are taxed as if received by a dependant (see above)

Medicare levy (2% of taxable income) is added where appropriate.

¶4-430 Roll-over superannuation benefits From 1 July 2017, a roll-over superannuation benefit is a superannuation member benefit or a superannuation death benefit that: • is paid as a lump sum • is paid from a complying superannuation plan or is an unclaimed money payment or arises from the commutation of a superannuation annuity, and • is paid to a complying superannuation plan or to an entity to purchase a superannuation annuity. A superannuation death benefit can only be a roll-over superannuation benefit if it is paid: • to a dependant of the deceased, or • to a child of the deceased who is less than 18 years of age, is financially dependent on the deceased and is less than 25 years of age, or has a disability. A superannuation lump sum benefit paid to a person with a terminal medical condition cannot be a rollover superannuation benefit. Before 1 July 2017, a superannuation death benefit was only a roll-over superannuation benefit if it arose from the commutation of a superannuation income stream paid to a person because of the death of their spouse. The primary purpose of a roll-over is to keep amounts in superannuation until they can be taken tax-free when the member reaches age 60, to consolidate amounts in one fund and to receive concessional tax treatment for investment income on the superannuation money. Tax consequences if a roll-over superannuation benefit is paid A roll-over superannuation benefit is generally a tax-free amount, and the individual is only assessable on the amount if it later forms part of a taxable superannuation benefit. There is an exception to the general rule if a roll-over superannuation benefit includes an amount that is an element untaxed in the fund and that untaxed roll-over amount exceeds the person’s untaxed plan cap amount ($1.565m for 2020/21; $1.515m for 2019/20). In that case, 47% tax on the excess untaxed rollover amount is levied on the person on whose behalf the roll-over is made. The tax is withheld by the originating superannuation fund. The amount of the roll-over superannuation benefit that does not exceed the person’s untaxed plan cap amount is tax-free.

¶4-435 Superannuation benefits paid to former temporary residents A former temporary resident who has left Australia may apply to a superannuation fund (or to the Commissioner if the fund has transferred the member’s superannuation to the Commissioner) for the release of their superannuation entitlements. Temporary residents must generally have left Australia before they can take their superannuation, even if they have retired from the workforce or have reached preservation age. A superannuation fund benefit paid to a former temporary resident is called a “departing Australia

superannuation payment” (DASP) for tax purposes. A DASP is subject to withholding tax at a rate that is higher than the rate imposed on superannuation payments in normal circumstances, eg where a superannuation benefit is paid on retirement (¶4-420). For 2020/21 and the previous two years, a superannuation fund must withhold tax at the following rates: • 0% on the tax-free component of the payment • 47% on the element untaxed in the fund of the taxable component of the payment (payments from a public sector fund would have such an element), and • 38% on the element taxed in the fund of the taxable component of the payment (most private sector superannuation funds would have only this element). If a former temporary resident fails to claim their superannuation money from their fund within six months of leaving Australia, the Commissioner may give the fund a notice requiring the fund to pay the superannuation money to the ATO. The ATO may then pay the money (less withholding tax) to the former temporary resident, or to their legal personal representative if the person has died. Alternatively, the ATO may roll the money into a superannuation fund, which will hold the money until it is claimed by the former temporary resident. Temporary residents who have not left Australia For a temporary resident who has not left Australia, the only circumstances in which a superannuation benefit can be paid are death, a terminal medical condition, permanent or temporary incapacity, and after their superannuation fund has been given a release authority by the member or the Commissioner. These payments would be taxed under the general rules for the taxation of superannuation benefits (¶4-420 and ¶4-425). For 2019/20 and 2020/21, an individual financially affected by COVID-19 may also apply for the release of up to $20,000 ($10,000 for 2019/20 and $10,000 for 2020/21) on compassionate grounds. This will be paid as a tax-free amount (¶4-400).

¶4-440 Transfer of superannuation between Australia and New Zealand Since 1 July 2013, members have been able to transfer retirement savings between APRA-regulated complying superannuation funds and New Zealand KiwiSaver schemes. Transfer from a KiwiSaver scheme to an Australian fund An amount in a KiwiSaver scheme may be transferred to an APRA-regulated complying superannuation fund (but not to a self managed superannuation fund which is regulated by the ATO). The transferred amount is: • not included in the assessable income of the receiving fund • non-assessable non-exempt income of the member, and • not subject to capital gains tax. An amount transferred from a KiwiSaver scheme is a non-concessional contribution for the member and subject to the non-concessional contributions cap arrangements. Generally, this means that any contributions that exceed the non-concessional contributions cap (ie $100,000 for 2020/21 or, in some cases, $300,000 spread over three years) are liable to excess non-concessional contributions tax unless the member elects to withdraw the excess amount (¶4-240 and ¶4-245). An amount is not counted against the non-concessional contributions cap if the trustee of the complying superannuation fund is informed by the KiwiSaver scheme provider or by the member that the amount has already been counted towards the cap, eg an amount that was first contributed to an Australian superannuation fund and was later transferred to a KiwiSaver scheme. Although a transferred amount is treated as a personal contribution, it is not deductible and does not

entitle the member to a government co-contribution or a spouse contribution offset. New Zealand-sourced savings transferred to the Australian fund would generally be subject to Australian taxation rates and superannuation rules, except that the New Zealand-sourced savings will not be available to the member until the member reaches the KiwiSaver retirement age of 65 and cannot be transferred to an SMSF. Australian-sourced superannuation transferred to New Zealand A superannuation benefit paid to a KiwiSaver scheme from an APRA-regulated complying superannuation fund is non-assessable non-exempt income of the member. The transferred amount is generally subject to New Zealand taxation rates and superannuation rules except that the Australiansourced savings will be available to the member on retirement at or after age 60.

¶4-450 Superannuation income streams which commenced before 1 July 2007 Superannuation income streams that commenced on or after 1 July 2007 are taxed as described in ¶4420. Tax treatment depends on the age of the recipient, the tax-free and taxable components of the benefit, and whether the income stream comes from an element taxed in the fund or an element untaxed in the fund. Individuals who were already receiving a superannuation income stream at 1 July 2007 retain the pre-1 July 2007 tax-free deductible amount unless a trigger event occurs. The tax-free deductible amount is, basically, the amount of the income stream received in the year that is the return to the individual of their own capital that was used to purchase the income stream. A trigger event would be the person reaching age 60 or dying, or the income stream being commuted to a lump sum. If a trigger event occurs, the taxfree amount is the sum of the unused undeducted purchase price and a pre-July 83 amount where relevant. Despite the continuance of the pre-1 July 2007 deductible amount, the tax treatment of the income stream is moved from an annual to a per payment basis. As a result, the annual deductible amount has to be converted to a per benefit figure. This is achieved by apportioning the annual deductible amount across each superannuation income stream according to the value of each superannuation income stream benefit received in the year. The portion of the deductible amount applying to a particular benefit is the tax-free component for that benefit. Example Matilda is aged 56 and is receiving a superannuation pension which commenced on 1 January 2007. Matilda receives monthly superannuation income stream benefits of $1,000 and her annual deductible amount is $5,000. The tax-free component of the $1,000 benefit is calculated as follows: Step 1. Calculate the proportion of the particular superannuation income stream benefit to the total of the superannuation income stream received in the year:

$1,000 $1,000 × 12 months

= 8.33%

Step 2: Multiply the annual deductible amount by the percentage calculated in Step 1:

$5,000 × 8.33% = $417 The tax-free component of the superannuation income stream benefit is $417. The taxable component of the benefit is $583.

¶4-480 Superannuation split on relationship breakdown Spouses whose relationship has broken down may be able to split their superannuation entitlements in the same way as they can divide up other assets. The superannuation splitting rules apply to spouses who are legally married and also to spouses in de facto relationships. Spouses can make a superannuation agreement that specifies how a superannuation interest will be

divided if their relationship breaks down. If the spouses are unable to agree about how to divide a superannuation interest, the Family Court has the power to make an order about the superannuation interest that will bind the superannuation fund trustee. Such an order will usually be made as part of a broader court order dealing with other property of the relationship. The court can make an order either about how a superannuation interest is to be split, or an order to flag a superannuation interest. A flagging order prevents the fund trustee from dealing with the superannuation interest by, for example, paying it to the member. At a later appropriate time, a flag lifting order can be made so that the fund trustee is again empowered to deal with the superannuation interest. Splitting of superannuation interests A “superannuation interest” means an interest that a person has as a member of an eligible superannuation plan, but does not include a reversionary interest. The superannuation interest of a member spouse may be split upon relationship breakdown (an interest split), or the split may occur when a payment of the interest is made, eg upon retirement (a payment split). Alternatively, the spouses may agree to “flag” the superannuation interest, whether by agreement or court order, and to decide on the splitting at a later date. Such a flag acts as a statutory injunction that prevents the trustee from making a splittable payment to the member spouse. The flag postpones the valuation time and splitting of the interest until the flag is lifted. It is a useful arrangement where the interest is a defined benefit or where payment of the interest is imminent, because, for example, the parties are close to retirement. Payment splits A “payment split” is a division of a superannuation interest when a benefit becomes payable to the member spouse who has satisfied a condition of release, even if the member spouse elects to roll over the interest to another superannuation provider. Splittable payments are: • a payment to the spouse or to another person for the benefit of the spouse (eg where the spouse rolls over a superannuation interest into a new fund), and • a payment to the legal personal representative of the spouse or to a reversionary beneficiary, after the spouse’s death. Non-splittable payments include: • payments to a member spouse made on compassionate grounds • payments because of severe financial hardship or permanent or temporary incapacity • payments of insured benefits where the member is no longer gainfully employed • payments made in either the Commonwealth Superannuation Scheme (CSS) or Public Sector Superannuation Scheme (PSS) where the member is being assessed for total and permanent disablement, and • payments to a reversionary beneficiary on behalf of a child. Interest splits An “interest split” occurs where a superannuation interest is created in the same fund for the non-member spouse, or an amount is rolled over to another fund for the benefit of the non-member spouse. The member’s interest is proportionately reduced by the non-member spouse’s new entitlement. In some cases, non-member spouses can request payment of their entitlement as a lump sum (eg on retirement, attaining age 65 or permanent incapacity). For an interest split to occur, the superannuation interest must be an accumulation interest that is in the growth phase, not a defined benefit interest. An interest split can apply to an allocated pension that is

being paid. Splitting a superannuation interest Where a payment split occurs and the superannuation interest is a lump sum entitlement, this will result in two superannuation payments being made, one to the member spouse and the other to the non-member spouse. The normal preservation rules (¶4-400) will apply. This means that if a condition of release has not been satisfied, the non-member spouse’s payment will have to be rolled over to another superannuation fund or an account will have to be created within the same fund. The non-member spouse’s superannuation benefit may be made up of two components — a tax-free component and a taxable component. The relevant proportions of each component reflect the proportions such components made up of the member’s superannuation interest before it was split with the nonmember spouse. The two components of a superannuation benefit and their tax treatment are discussed at ¶4-420. The proportioning rule that applies to fairly divide a non-member spouse’s superannuation benefit into the two components is illustrated in the following example. Example Peter has a superannuation interest with a value of $400,000. The interest includes a tax-free component of $100,000 and a taxable component of $300,000. On the breakdown of Peter’s marriage, there is a 50/50 payment split with Molly, Peter’s non-member spouse. Molly’s superannuation interest resulting from the payment split would be made up of tax-free and taxable components in the same proportions as Peter’s original superannuation interest. The tax-free percentage of Peter’s superannuation interest before the payment split is:

tax-free component value of interest

=

$100,000 $400,000

= 25%

The taxable percentage of Peter’s superannuation interest would be 75%. Molly’s $200,000 superannuation interest is divided into the two components in the same proportions: tax-free 25% and taxable 75%.

Splitting pensions or annuities Where a payment split occurs in respect of a member spouse’s superannuation interest that is a pension entitlement, the pension itself is split, with each pension payment being a splittable payment. A payment split may apply to a pension that has already commenced to be paid to the member spouse prior to the relationship breakdown. If permitted by the fund’s governing rules, the non-member spouse may convert the pension entitlement to a lump sum. Splitting the pension may result in two regular payments being made in respect of the same pension — one to the member spouse and the other to the non-member spouse. Superannuation income streams are taxed as described in ¶4-420. The same consequences arise on the splitting of an eligible annuity, that is, an annuity purchased wholly of rolled-over amounts. Capital gains tax consequences of superannuation splits A capital gain or loss is disregarded where a person makes a gain or loss in respect of a right because of a superannuation agreement. This exemption would apply, for example, where the Family Court sets aside a superannuation agreement on establishing that a spouse has entered into the agreement under duress. A capital gain or loss arising on payments from a superannuation fund to a non-member spouse is also disregarded. The exemption from CGT consequences applies even though the non-member spouse acquires their right to the payment for consideration (the consideration being the giving up of a right to a property settlement in respect of their superannuation interests). In normal circumstances, the exemption

would be lost if the person receiving the payment is not a fund member and acquired the right to the payment for consideration. Superannuation splitting upon the breakdown of a relationship is discussed further at ¶18-200.

SUPERANNUATION GUARANTEE SCHEME ¶4-500 Superannuation guarantee scheme The SG scheme requires employers to provide a minimum level of superannuation support in each quarter for their employees. The minimum level of superannuation support (the “charge percentage”) is 9.5% of ordinary time earnings for 2020/21 (the same as for 2019/20). Employer SG contributions may be made to any complying superannuation fund or RSA for the benefit of an employee. Employers can make their contributions to the Small Business Superannuation Clearing House which is administered by the ATO if they have fewer than 20 employees or have an annual aggregated turnover of no more than $10m. Employer superannuation contributions made in accordance with a Commonwealth, state or territory law, an industrial award or occupational superannuation arrangement may be counted towards the SG obligations of the employer. From 1 January 2020, employer contributions after an employee enters into a salary sacrifice arrangement cannot count as SG contributions (¶4-560). Employers who fail to make sufficient contributions for an employee for a quarter are liable to SG charge (¶4-560) equivalent to the amount of the contribution shortfall plus an interest component and an administration charge. The shortfall component of the SG charge is distributed by the ATO to a complying superannuation fund or RSA for the benefit of those employees in respect of whom the charge was paid. In exceptional cases, the shortfall component may be distributed directly to the employee (eg if the employee has retired because of invalidity, or is aged at least 65 and requests payment). An SG amnesty that runs from 24 May 2018 to 7 September 2020 allows employers to self-correct certain underpayments of SG amounts without incurring additional penalties that would normally apply (¶4-560). Employers are generally required to give their employees a choice as to the fund into which SG contributions are to be paid. An employer who fails to contribute in compliance with choice of fund rules (¶4-580) is liable to a penalty in the form of an increased SG charge. Generally, employer SG contributions are tax deductible (¶4-210), but SG charge payments are not. The SG scheme is administered by the ATO on a self-assessment basis.

¶4-510 Quarterly payment of SG amounts SG contributions must be paid by an employer at least quarterly. The SG year is divided into quarters ending 30 September, 31 December, 31 March and 30 June. An employer must make SG contributions by the 28th day after the end of the quarter. An employer who fails to make the required contributions by the due date must complete an SG statement, and pay its SG charge liability, by the 28th day of the second month following the end of the quarter. Providing information to employees An employer who is covered by the Fair Work Act 2009 must provide information on an employee’s pay slips about the employer’s superannuation contributions made for the benefit of the employee. This obligation does not generally apply to public sector employers or some unincorporated private sector employers. Affected employers must include on an employee’s pay slip: • the amount of contribution that the employer actually made during the period to which the pay slip

relates, or • the entitlements to superannuation that accrued for the employee during the relevant period. Single Touch Payroll reporting Single Touch Payroll (STP) reporting requires employers to provide information to the ATO at the same time certain payroll events occur, eg when salary or wages are paid. Employers who provide information under STP are exempted from a number of reporting obligations that may otherwise apply at a later date, eg the obligation to notify the ATO of amounts withheld from payments or to provide payment summaries for termination payments or annual reports to the ATO. Employers must still provide payment summaries for amounts that are not reported through STP, eg RESCs (¶4-215). Employers are not required to use STP to report contributions paid to a superannuation fund for employees. The Commissioner receives this information from the funds. For quarters commencing on or after 1 January 2020, when reporting an employee’s ordinary time earnings or salary or wages to the ATO, an employer must also report the amount of an employee’s ordinary time earnings or salary or wages that is paid into superannuation by the employer under a salary sacrifice arrangement. Single Touch Payroll reporting commenced on 1 July 2018 but only for “substantial employers”, that is employers who had 20 or more employees or members of a wholly owned group that had 20 or more employees. When STP was extended to all employers from 1 July 2019, the ATO said it would adopt a “flexible, reasonable and pragmatic” approach because small employers might require additional time to be ready for STP. Various ATO concessions were made available for small employers, including: • employers with fewer than five employees were offered alternative options such as allowing those who rely on a registered tax agent to report quarterly for the first two years • for the first year, penalties would not be imposed for small employers who made a genuine attempt to transition to STP or for missed or late reports, and • employers experiencing hardship or in areas with intermittent or no internet connection would be exempted from STP reporting. Extensive information about STP can be found on the ATO website at: www.ato.gov.au/Business/SingleTouch-Payroll/

¶4-520 Employees covered by SG scheme The SG scheme applies to all employers in respect of their full-time, part-time and casual employees, with only limited exceptions. In general terms, an “employee” is a person who is paid salary or wages in return for work or services rendered, and who receives payment for work under a contract that is wholly or principally for that person’s labour. The “employer” is the person liable to make the payment. Under the SG scheme, “employee” may extend to persons who may not be employees within the ordinary meaning. The most significant inclusion is of persons who work under a contract that is wholly or principally for their labour. This covers contracts where the labour content exceeds 50% of the value of the contract. Contractors Employers who use contractors are not required to make SG contributions for them as long as the contractors are not deemed to be employees for SG purposes. The contractors who are deemed to be employees are those who work principally under a contract for their labour (ie they are paid for their services) and not, for example, for the supply of goods. Unfortunately for employers, the distinction between employees and contractors can be difficult to draw in

many circumstances. Excluded employees There are some employees for whom an employer does not have to make contributions for. These include: • part-time employees (ie those who work less than 30 hours a week) who are aged under 18 years • certain senior foreign executives • resident employees employed by non-resident employers for work done outside Australia, and • employees who receive salary or wages of less than $450 in a calendar month from an employer. The age of an employee does not affect the employer’s obligation to make SG contributions, unless the employee is under 18 years and only working part-time. Before 2013/14, an employer was only required to contribute for an employee up to age 70. Employees aged 70 or older could not benefit from SG contributions, although an industrial award or agreement may have imposed an obligation on the employer to contribute. Employees with multiple employers From 1 January 2020, an employee who receives income from multiple employers can apply to the Commissioner to opt out of the SG regime in respect of one or more employers. As SG contributions are counted as concessional contributions and the concessional contributions cap is $25,000 (¶4-234), high-income earners could be liable to penalties (¶4-235) if contributions were made on their behalf by multiple employers. To avoid being penalised for excess contributions, an employee with multiple employers may apply for the Commissioner to issue them with an “employer shortfall exemption certificate” for a specified employer of the employee and a specified quarter. An application can only be made for a current employer and a separate application must be made for each employer for whom the employee wants a certificate to be issued. The Commissioner may only issue a certificate if satisfied that: (i) the employee is likely to exceed their concessional contributions cap if the certificate is not issued, and (ii) after the certificate is issued, the employee will still have at least one employer who must make SG contributions for them in order to avoid liability for SG charge. The Commissioner’s decision to issue a certificate must be notified in writing to the employee that made the application and to the employer covered by the application. The certificate relieves the employer of SG obligations but it does not affect an employer’s obligations under a workplace award or agreement. Consequences for an employer An employee who successfully applies for an employer shortfall exemption certificate for a particular employer can negotiate with the employer to receive additional cash or non-cash remuneration instead of SG contributions. An employer may, however, choose to disregard the certificate and continue to make SG contributions for the employee. This could be the case, for example, if the employer and the employee cannot agree on alternative remuneration for the relevant quarter or the employer does not have enough time to adjust contributions for the employee. An employer is not liable for SG charge if, relying on the employer shortfall exemption certificate, the employer does not make SG contributions for the employee for the quarter to which the certificate relates.

¶4-540 How much does an employer have to contribute? For SG quarters commencing on or after 1 January 2020, the minimum level of superannuation support (the “charge percentage”) that an employer must provide for each employee to avoid incurring liability for

the SG charge (¶4-560) is 9.5% of an employee’s “ordinary time earnings base”. For earlier SG quarters, an employer was required to provide for each employee 9.5% of an employee’s “ordinary time earnings”. An employer’s obligation to make SG contributions for an employee is limited to the “maximum contribution base” (see below). The charge percentage will increase over a number of years until it reaches 12% for the year starting 1 July 2025. The increase in the charge percentage will be as follows: Year commencing

Minimum SG contribution

1 July 2020

9.5%

1 July 2021

10%

1 July 2022

10.5%

1 July 2023

11%

1 July 2024

11.5%

Year starting on or after 1 July 2025

12%

Ordinary time earnings base The ordinary time earnings base of an employee is used to calculate the minimum SG contribution required for quarters commencing on or after 1 January 2020. An employee’s ordinary time earnings base is the sum of: (i) their ordinary time earnings, and (ii) the amount of ordinary time earnings that the employee has sacrificed under a salary sacrifice arrangement and that has been contributed by the employer to a superannuation fund for the benefit of the employee. This definition ensures an employer’s obligation to make SG contributions for an employee is calculated on a pre-salary sacrifice base. Ordinary time earnings The ordinary time earnings of an employee is used to calculate the minimum SG contribution required for quarters commencing before 1 January 2020. The ordinary time earnings of an employee is the lesser of: • the total of the employee’s earnings for ordinary hours of work and earnings for over-award payments, shift loading and commission (but not including lump sum payments on termination of employment for unused annual leave, unused long service leave or unused sick leave), and • the “maximum contribution base” for the period The Full Federal Court has held that SG contributions were not payable by an employer in respect of the “additional hours” and “public holidays” components of employees’ salaries since these components did not form part of “ordinary time earnings”. Bluescope Steel (AIS) Pty Ltd v Australian Workers’ Union [2019] FCAFC 84. The ATO subsequently issued a decision impact statement, which outlines the ATO’s response to the Bluescope case with respect to the meaning of “ordinary time earnings” and “ordinary hours of work” as used in the SGAA. The ATO states that the conclusion reached by the Full Federal Court on the meaning of the terms “ordinary time earnings” and “ordinary hours of work” is consistent with the Commissioner’s long settled and published position in Superannuation Guarantee Ruling SGR 2009/2 on the meaning of the terms

“ordinary time earnings” and “salary or wages”. Maximum contribution base An employer is not required to provide SG contributions for the part of an employee’s ordinary time earnings base (or ordinary time earnings for quarters commencing before 1 January 2020) that exceeds the maximum contribution base. The maximum contribution base for 2020/21 is $57,090 for each quarter ($55,270 for 2019/20). Example Boris is employed as a web designer for Amalgam Technologies and has an ordinary time earnings base of $58,500 for the quarter ended 30 September 2020. The maximum SG contribution that Amalgam Technologies is required to make for Boris for that quarter is $5,424, which is 9.5% of $57,090.

An employer covered by an employer shortfall exemption certificate (¶4-520) has a maximum contribution base of nil in relation to an employee for the quarter to which the certificate relates. The effect is that the employer is not required to make contributions for the employee for the quarter. Employer obligations when JobKeeper payments are made Employers are not subject to additional SG obligations as a result of their participation in the JobKeeper scheme. Amounts of salary or wages that do not relate to the performance of work and are only paid to an employee because the employer participates in the JobKeeper scheme are excluded salary or wages for SG purposes. As a result, an employer does not need to take those amounts into account in calculating the minimum SG contribution to be made for the employee (Superannuation Guarantee (Administration) Regulations 2018 reg 12A). Example An employee’s pre-COVID wages were $1,000 per fortnight and she continues to perform the same work although her employer pays her an additional $500 per fortnight. The employer is required to pay her $1,500 per fortnight as a condition of the employer participating in the JobKeeper scheme. The employer is only required to calculate the minimum SG contributions to be made for the employee based on the amount of the payment that relates to the work she performs, ie based on $1,000 per fortnight. The employer is not required to take the additional $500 per fortnight into account in calculating the minimum contributions required to be made.

¶4-560 Liability to SG charge if insufficient contributions An employer who fails to make the required SG contributions (¶4-540) by the due date (ie by the 28th day after the end of a quarter) must complete an SG statement and pay SG charge. The SG charge is made up of: • the shortfall in the SG contributions for the quarter • interest at 10% per annum on the shortfall, calculated from the beginning of the quarter up to the day the employer lodges an SG statement and pays the SG charge, and • an administration component of $20 for each employee for whom there is a shortfall. SG charge is payable by the 28th day of the second month after the end of the quarter for which liability to SG charge arose. An additional penalty may be imposed if the employer fails to make SG contributions in compliance with the choice of fund rules (¶4-580). When an employer pays SG charge, the Commissioner generally distributes the shortfall component to the superannuation account of the employee or employees who are entitled to benefit. In exceptional cases, the Commissioner may pay the amount directly to an employee, eg if the employee is aged 65

years or more, if the employee has retired because of permanent incapacity or if the employee has a terminal medical condition. If the employee has died, the Commissioner must pay the amount directly to the legal personal representative of the employee. Consequences of non-compliance with SG obligations Non-compliance with the SG obligations can have the following onerous consequences for an employer: • although most employer superannuation contributions for employees are tax deductible, the SG charge is not • calculation of the SG shortfall (one of the components of the SG charge) is based on an employee’s salary or wages, which may be higher than the employee’s ordinary time earnings, and therefore more costly to the employer, and • the 10% interest liability is calculated from the commencement of the relevant quarter to the day the employer lodges the SG statement and pays the SG liability — interest is imposed for the whole quarter even if, for example, the employer failed to comply during only the last month of the quarter. Employers who make SG contributions for an employee later than the 28th day after the end of a quarter may be able to offset the late payment against the individual SG shortfall and nominal interest components of the SG charge for the relevant quarter. The Commissioner can direct employers who fail to comply with their SG obligations to undertake an approved course relating to their obligations. Failure to comply with such a direction could result in penalties including up to 12 months imprisonment. Personal liability of directors for unpaid SG amounts Directors of companies that breach their SG obligations and fail to pay the required amounts to the ATO may be personally liable for the unpaid SG amounts. The ATO may commence recovery action against a director for SG liabilities that remain unpaid 21 days after the Commissioner has issued a director penalty notice to the director. The available defences for a director who has been issued a director penalty notice are: • the director was not involved in the management of the company for a good reason, such as illness, and it was reasonable for the director not to be involved, or • the director took all reasonable steps to ensure the company met its SG obligations, to appoint an administrator or to have the company wound up, or there were no reasonable steps that could have been taken. SG amnesty from 24 May 2018 to 7 September 2020 An SG amnesty that runs from 24 May 2018 to 7 September 2020 allows employers to correct their underpayments of SG amounts for the quarters starting from 1 July 1992 to 31 March 2018. An employer is eligible to participate in the amnesty for a quarter if: • during the amnesty period from 24 May 2018 to 7 September 2020 they disclose to the Commissioner information about their SG shortfall for the quarter and that information has not previously been disclosed, and • the Commissioner has not informed the employer that the Commissioner is examining or intends to examine the employer’s SG non-compliance for the quarter. The amnesty allows employers to voluntarily self-correct their SG non-compliance. An employer that takes part in the amnesty would be required to pay all SG shortfall amounts owing to their employees, including the nominal interest and general interest charge. There are three benefits for employers that take advantage of the amnesty: (1) Their SG shortfall amount would have no administrative component, normally $20 per employee per

quarter. (2) They would not be liable to additional penalties for failure to provide an SG statement by the due date. (3) A deduction would be allowed for payments of SG charge imposed on SG shortfall disclosed under the amnesty. Employers adversely affected by COVID-19 can make special payment arrangements with the ATO, including: (i) making flexible payment terms and amounts which the ATO will adjust if the employer’s circumstances change, and (ii) extending the payment plan to beyond 7 September 2020 (although only payments made by 7 September 2020 would be deductible). ATO advice to employers about the SG amnesty is set out at: www.ato.gov.au/Business/Super-foremployers/Superannuation-guarantee-amnesty/ The ATO advice takes account of the effect of COVID-19 on employers.

¶4-580 Choice of fund rules Employers are generally required to give their employees a choice as to the fund into which SG contributions are paid. It is only if the employee fails to choose, or chooses a fund which cannot be used by the employer, that the employer may choose the fund. An employer will most commonly comply with the choice of fund rules by contributing in one of the following ways: • to a fund chosen by the employee when written notice is given to the employer — a choice can be made every 12 months, or more often if the employer allows • to a fund chosen by the employee after receiving a standard choice form from the employer, or • most commonly, to a default fund chosen by the employer after the employee fails to make a choice. Employers with fewer than 20 employees or with an annual aggregated turnover of no more than $10m can make SG contributions to the Small Business Superannuation Clearing House, which will forward the contributions to the employee’s chosen fund. If an employee does not choose a fund, the employer can make contributions to the clearing house and instruct that the contributions be sent to a particular default fund selected by the employer. Penalties for failing to comply with choice of fund rules Penalties in the form of increased SG charge are imposed on an employer who does not comply with the choice of fund rules. This “choice penalty” is passed on to the relevant employees by the ATO. The amount of choice penalty for an employee is limited to $500, either for a particular quarter or for a notice period, which can consist of multiple quarters. Choice of fund initiated by employee An employee may initiate the choice process by giving the employer a written notice proposing a particular complying superannuation fund or RSA as the employee’s chosen fund. An employer may reject a fund chosen by an employee if the employee does not provide written evidence setting out: • prescribed information about the fund (eg contact details) • that the fund will accept the employer’s contributions for the employee, and • that the fund is a complying fund. Choice of fund initiated by employer

An employer must give a standard choice form to an employee, and thereby initiate the choice of fund process, unless the employee has chosen a fund by the time the employer would otherwise be required to give a form. The employer must provide a standard choice form: • within 28 days of the employee first commencing employment with the employer • within 28 days of an employee request for a form (but not if the employee has been given such a form within the last 12 months), or • within 28 days of the employer becoming aware that there ceased to be a chosen fund for the employee. Special rules apply where an employer makes SG contributions to a fund specified in an enterprise agreement or workplace determination. Such contributions are currently deemed to satisfy the choice of fund requirements — the employer does not have to give a standard choice form to the employee and the employee is not given the opportunity to choose their own superannuation fund. The Treasury Laws Amendment (Your Superannuation, Your Choice) Bill 2019, which is currently before Parliament, proposes that, where an employee is employed under an enterprise agreement or workplace determination made on or after 1 July 2020, the employer would be required to offer choice of fund to new employees. The employer would not be required to offer choice of fund to existing employees unless requested once a new agreement or determination is made. Default fund selected by employer If an employee does not choose a fund, the employer will contribute to a default fund. Since 1 January 2014, employers covered by a modern award have been required to make SG contributions to a default fund specified in the award and a superannuation fund is only able to be named in a modern award if it offers a MySuper product. MySuper products A MySuper product is a low-cost and simple superannuation product that can be provided by authorised superannuation funds. Significant features of MySuper products include: • specified duties for trustees, including a duty to deliver value for money as measured by long-term net returns, and to actively consider whether the fund has sufficient scale • a single diversified investment strategy, suitable for the vast majority of members who are in the default option • restrictions on unnecessary or excessive fees • a fair and reasonable allocation of costs between MySuper and other products, and • standardised reporting requirements written in plain English. Responsibility for the default fund process The Fair Work Commission is currently responsible for the default superannuation fund process, although a report released by the Productivity Commission on 10 January 2019 proposed major changes to the operation of the system. The report — Superannuation: Assessing Efficiency and Competitiveness — proposed a new way of allocating default members to products. Members would only be allocated to a default fund once, when they enter the workforce. New employees would be given a choice from a “best in show” shortlist of up to 10 superannuation products set by a competitive and independent process. Any member who did not have an existing account and who failed to choose a fund within 60 days would be defaulted to one of the products on the shortlist selected by sequential allocation. The final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial

Services Industry released on 1 February 2019 agreed with the Productivity Commission that default superannuation accounts should only be created for new workers or workers who do not already have a superannuation account. Default accounts should be carried over by members when they move jobs. The Royal Commission recommended that machinery be developed for “stapling” a person to a single default account. No action has yet been taken on these recommendations. Employer not liable for loss or damage An employer is not liable for any loss or damage arising from anything done by the employer in compliance with the choice of fund rules. If, for instance, an employee selects a fund from material provided by a superannuation trustee and the fund subsequently performs badly, the employer would not be liable to compensate the employee. The protection does not extend to things done by the employer which are not undertaken in complying with choice of fund. Trustee of superannuation fund must not offer inducements to an employer A trustee of a superannuation fund is prohibited from offering inducements in the form of goods or services to an employer in return for the employer arranging for employees to be members of the fund. A trustee who breaches the prohibition may be liable to a substantial monetary penalty. Anyone who suffers loss or damage as a result of such action by the trustee may bring an action for recovery of the amount of the loss or damage from the trustee. There is, however, no right to recover against the employer who may have benefited from the trustee’s contravention.

FOREIGN SUPERANNUATION FUNDS ¶4-600 Australian or foreign superannuation funds A superannuation fund may be an Australian or a foreign fund. Only Australian funds can be complying funds and receive concessional tax treatment (¶4-320). A superannuation fund is a foreign superannuation fund if it is not an Australian superannuation fund. A foreign superannuation fund is taxed as a non-complying fund (¶4-340). A fund is an Australian superannuation fund at a time if: • the fund was established in Australia or any asset of the fund is situated in Australia at that time • at that time, the central management and control of the fund is ordinarily in Australia (this may be so even if that central management and control is temporarily outside Australia for a period of not more than two years), and • either the fund has no active member at that time (ie a member who currently contributes to the fund or for whom contributions are currently made) or the accumulated entitlements of resident active members is 50% or more of the total accumulated entitlements of all active members at the time. If an Australian superannuation fund ceases to satisfy the conditions for being an Australian superannuation fund, it ceases to be a complying fund and will be subject to tax at 45% on the fund’s total assets less any undeducted contributions. The movement overseas of members of an SMSF can have unintended tax consequences, particularly for a fund with only one member, or where a couple are the only members. If they move overseas, the fund may cease to be an Australian superannuation fund and the tax concessions flowing from complying fund status will be lost. Example A married couple are trustees of an SMSF established in 2001. The husband accepts a two-year contract to work overseas, intending to return to Australia after the contract ends. His wife joins him for the term of the contract. They make no contributions to

the fund after leaving Australia. It is accepted that the central management and control of the fund is ordinarily in Australia and the fund will be treated as an Australian superannuation fund. If the husband’s contract was extended and the couple remained overseas for considerably more than two years, central management and control of the fund would not ordinarily be in Australia and the fund would not be treated as an Australian superannuation fund.

A member is not an active member if, at the relevant time, they are not a resident of Australia and the only contributions made to the fund on their behalf are: (a) contributions made before they ceased to be a resident; and (b) contributions made after they ceased to be a resident but that relate to when they were a resident. Superannuation fund residency is discussed further at ¶5-110.

¶4-650 Superannuation benefits from foreign superannuation funds The tax treatment in Australia of a payment from a foreign superannuation fund depends on when the payment is received, ie whether it is received within six months of the person becoming an Australian resident or more than six months after the person becomes an Australian resident. Where the superannuation benefits are paid within six months of the person becoming an Australian resident, they are tax-free and can be credited directly to a complying superannuation fund without tax implications, provided the payment relates to overseas service while a non-resident and does not exceed the member’s vested benefit in the paying fund at the time of payment. The payment is treated as an undeducted contribution in the receiving fund. If the taxpayer has been a resident of Australia for at least six months when payment is made, overseas superannuation benefits may, unless the taxpayer elects otherwise, give rise to taxable income to the taxpayer where the benefit is either paid to the member or on behalf of the member directly to an Australian superannuation fund. The amount of taxable income is the increase in the fund balance from the date of becoming a resident to the date of payment. This amount is taxed as income at the taxpayer’s marginal tax rate. If foreign tax has been paid on the payment, the taxpayer may be allowed a credit for the foreign tax paid. As an alternative, taxpayers who are having their overseas superannuation paid directly to an Australian complying superannuation fund can elect to have part of the payment treated as a taxable contribution in the Australian fund. By doing so, the fund, rather than the individual, will include the relevant amount in assessable income and any tax is paid at the concessional superannuation fund rate of 15%. Pension paid by foreign superannuation fund Subject to the provisions of a double tax agreement, a pension paid by a foreign superannuation fund (eg a UK pension fund) to an Australian resident is assessable in Australia. The whole of the pension amount, reduced by the deductible amount, if any, is included in the taxpayer’s assessable income. No offset is allowed as the fund is not a taxed complying superannuation fund. Transfers of UK pension benefits to Australian superannuation funds Transfers of amounts from pension funds in the United Kingdom to Australian superannuation funds were severely affected by changes to the UK pension rules from 6 April 2015. Before that date, it was possible to transfer pension benefits from the UK to Australia if the fund was registered as a Qualifying Recognised Overseas Pension Scheme (QROPS). Changed rules only permit an overseas fund to qualify as a QROPS if the money is preserved in the fund until age 55, with early release permitted only on grounds of ill-health. This creates difficulties for Australian funds as Australian legislation permits or requires early release on a number of other grounds, eg compassionate grounds, financial hardship and refund of excess contributions. As a result of this change no Australian superannuation funds are recognised as QROPS. This means that, until this impasse is resolved, they are not able to accept transfers of pension fund entitlements from the UK.

SELF MANAGED SUPERANNUATION FUNDS The big picture

¶5-000

Background and introduction to SMSFs

¶5-010

What is an SMSF?

¶5-020

Benefits of SMSFs

¶5-040

Obligations on SMSF trustees

¶5-050

Federal Budget proposed changes to SMSFs

¶5-060

Establishing an SMSF The basic requirements to establish an SMSF

¶5-100

Duties of SMSF trustees

¶5-110

Fund accounts SMSF member accounts

¶5-200

Event-based reporting

¶5-205

Market value reporting

¶5-210

Pooled or separated investment accounts

¶5-220

Annual returns

¶5-225

The trust deed, SISA and investments Regulation of SMSFs

¶5-300

The SMSF trust deed

¶5-310

The sole purpose test

¶5-320

The in-house assets test

¶5-330

Acquisition of assets

¶5-350

Trustee allowed to borrow in limited circumstances ¶5-360 Trustee not to lend to members

¶5-370

All transactions to be on an arm’s length basis

¶5-380

Trustee not to charge assets of the fund

¶5-390

The SMSF investment strategy

¶5-400

Acquisition of real estate by an SMSF

¶5-500

Taxation of investments in an SMSF

¶5-600

SMSF reserves

¶5-700

Death benefit nominations and SMSFs

¶5-720

Providing SMSF advice

¶5-800

¶5-000 Self managed superannuation funds

The big picture Self managed superannuation funds (SMSFs) are considered an alternative to APRA-regulated funds which are administered by arm’s length professional trustees and managers. The main advantages of SMSFs are that members, who are also required to be trustees, can have greater control and flexibility over investments and investment decisions so that the overall operation of the fund can be tailored for their needs. Background to self managed superannuation funds: SMSFs play a significant part of the superannuation scene in Australia and now represent about 27% of the total amount invested by Australians in superannuation. ¶5-010 What is an SMSF?: An SMSF is a superannuation fund with fewer than five members, where the members actively participate in the fund’s management. ¶5-020 Benefits of SMSFs: An SMSF provides control, flexibility, taxation advantages and potential cost savings for the superannuation savings of members. Other benefits include estate planning opportunities and protection from creditors. ¶5-040 Disadvantages of SMSFs: The disadvantages of SMSFs may include the legal obligations imposed on trustees, costs and time involved to manage the fund, and lack of access to the Superannuation Complaints Tribunal/Australian Financial Complaints Authority. ¶5-050 Setting up an SMSF: Once the decision has been made to set up an SMSF, there are a number of administrative procedures to be followed to ensure the fund is a complying fund to qualify for the concessional tax treatment. This requires the fund to have a suitable trust deed, appointing trustees, completing ATO trustee declarations and notifying the ATO, as the regulator of SMSFs, about the establishment of the fund. It is also necessary that a fund has a bank account to enable transactions, such as the receipt of contributions and payment of benefits, to take place. ¶5-100 Duties of trustees: The trustee of an SMSF is subject to various obligations imposed under statutory law, general trust law and the fund trust deed. Some of the duties of a trustee deal with the three principal areas of fund operation — acceptance of contributions, investment of funds and payment of benefits. ¶5-110 SMSF accounts: The accounts of an SMSF can be set up in a number of different ways. In an SMSF which is in accumulation phase, each member will usually have one account which represents their balance in the fund at a particular time. If the member is using all of their balance in the SMSF to draw an income stream, they will have one account. However, it is possible for a member to have one account in accumulation phase as well as one or more income stream accounts in the fund. In a very small number of SMSFs, a member may have particular investments of the fund allocated to them if they choose. Separate investment accounts allow each member to adopt a separate and distinct investment strategy with different individual investments. This is appropriate when there are members of different ages and investment profiles in the same fund. ¶5-200 The trust deed: The trust deed contains the rules of the SMSF and forms part of the governing rules of the SMSF. These rules are used to determine the rights and obligations of the trustee, members and other parties who deal with the fund. ¶5-310 The sole purpose test: The sole purpose test is fundamental to the existence of the fund and maintenance of the relevant taxation concessions, that is, solely providing retirement benefits to members on retirement or a similar event or, in the event of the member’s death, benefits for dependants and/or the member’s legal representative. ¶5-320 The in-house assets test: SMSFs and other types of superannuation funds are limited to having inhouse assets of no more than 5% of the market value of the fund’s total assets. An in-house asset includes a loan to, an investment in, a related party or related trust and lease of fund assets to a related party. Certain assets are excluded from the definition due to many exemptions and transitional rules that applied from 1999 to 2009. ¶5-330 Acquisition of assets: A member of a fund may ask the trustee to accept a contribution in specie. If accepted, the market value of the assets at the time of the contribution will be the relevant amount

contributed to the fund. If assets are transferred from a related party, the trustee must ensure the assets comply with the Superannuation Industry (Supervision) Act 1993 (SISA), s 66, which prohibits the acquisition of an asset, with some limited excpetions, by the trustee from a related party. ¶5-350 Trustee allowed to borrow in limited circumstances: The trustee of an SMSF must not borrow or maintain an existing borrowing of money, except in limited circumstances. A borrowing is allowed where the trustee needs to cover settlement on the purchase of an asset which was not anticipated at the time of purchase or where a benefit payment must be made. Any borrowing must be short term, ie less than seven days for securities transactions and 90 days for benefit payments. In addition, the borrowing cannot exceed 10% of the value of the fund’s assets. An SMSF may also borrow for the purposes of a limited recourse borrowing arrangement (LRBA). ¶5-360 All transactions to be on an arm’s length basis: The trustee or investment manager must invest the money of the fund on an arm’s length basis (s 109 SISA). This does not preclude the trustee dealing with parties who are closely associated with the fund — it merely requires that the transaction stands up to commercial tests. ¶5-380 The investment strategy: All types of superannuation funds, including SMSFs, are required to have an investment strategy. When an investment strategy is being prepared it needs to take into account the circumstances of all the fund members, including their age and risk tolerance. The trustees need to take into consideration the diversification of the fund’s investments, asset concentration, liquidity and the ability of the fund to pay benefits as they come due and payable. In addition, the investment strategy must take into account the insurance needs of members and be reviewed regularly. ¶5-400 Acquisition of real estate by an SMSF: The legislation has many rules surrounding fund investments including residential and commercial real estate. Whether real estate can be acquired by an SMSF depends on the investment strategy of the fund, who the property was acquired from and the manner in which it is owned. Also, the value of the real estate and a member’s total superannuation balance as at 30 June in the previous financial year may have a bearing on whether it can be transferred to the SMSF as a non-concessional or concessional contribution. ¶5-500 Taxation of investments in the fund: The taxable income of an SMSF is taxed at 15% and the nonarm’s length income component of the fund’s taxable income is taxed at 45%. Taxable income includes amounts earned by the fund on investments and taxable contributions. Taxable contributions include all contributions made by an employer and personal deductible contributions for which a fund member has claimed a tax deduction. Taxable capital gains receive a 33⅓% (one-third) discount on the disposal of assets held for longer than 12 months, that is, they are taxed at an effective rate of 10%. All income and taxable capital gains earned on assets that support the pension are tax exempt, with the exception of non-arm’s length income earned on assets in pension phase. ¶5-600 Reserves: The trust deeds of some SMSFs allow reserves to be maintained by the fund. Reserves are amounts set aside within the fund that are available for various purposes including smoothing investment returns and retaining assets in the fund. In order to maintain reserves a fund is required to have a reserving strategy which is similar to the fund’s investment strategy. Amounts transferred from reserves to a member’s account may count against the member’s concessional contributions cap. It is also possible to hold contributions for short periods in an unallocated contributions account which may provide some advantages in managing excess concessional contributions. The ATO is concerned over the potential abuse of the new contribution rules and a member’s transfer balance cap by the use of reserves and has published SMSF Regulator’s Bulletin SMSFRB 2018/1 as a result. ¶5-700 Providing SMSF advice: Since 1 July 2016, SMSF advice can be provided only by an adviser who is authorised under a limited licence or under a full financial planning licence. The exemption previously available to accountants from certain requirements in relation to the establishment of an SMSF has not applied since 30 June 2016. ¶5-800

¶5-010 Background and introduction to SMSFs

Small superannuation funds have been a part of the superannuation scene for many years. Initially, they were used mainly by small business owners and self-employed people. However, these days employees and those nearing retirement are more likely to have an SMSF. As at March 2020, there were 596,180 SMSFs in existence with total assets exceeding $675.6 billion. This compares with 586,178 funds as at March 2019 with total assets exceeding $704.2 billion. The decrease in asset values is principally due to the drop in investment markets as a result of the COVID-19 epidemic. An SMSF is a special category of superannuation fund defined under the SISA. It must have fewer than five members who are required to be the fund trustees and actively participate in decisions about the fund’s management, investment and general administration. As a group, SMSFs represent over 99% of the number of superannuation funds in Australia and account for about 27% of all superannuation assets. The growth in SMSFs over the past decade has been significant both in terms of the increase in the number of funds and the assets under their control. For example, the net growth in the number of SMSFs during the year ended March 2020 was 10,002 funds. Under the operation of the SISA, SMSFs have access to favourable tax concessions if they satisfy the relevant legislative requirements just like the larger superannuation funds. The close relationship existing between the trustees and members of SMSFs means that the legislation is regarded as less onerous than the prudential standards for larger superannuation funds. The reason is that with the larger funds the relationship between the trustees and the fund members is more remote and it is unusual fund trustees are also members of the same fund. The regulator of SMSFs is the Australian Taxation Office (ATO). All other superannuation entities, including approved deposit funds and retirement savings accounts, are regulated by the Australian Prudential Regulatory Authority (APRA). For income tax purposes, an SMSF must meet the requirements which are similar to other superannuation funds regulated under SISA. If these requirements are satisfied: • tax deductions are available for contributors if certain conditions are met subject to the requirements of the income tax law • the fund’s income is taxed at: – 15% on its taxable income and taxable capital gains (a one-third discount applies to this rate on capital gains made after 12 months of acquisition of the asset) – 15% on taxable contributions where a member’s tax file number (TFN) has been notified – 47% where a member’s TFN has not been notified which can be subject to a tax offset in certain circumstances – 45% on non-arm’s length income • benefit payments receive concessional treatment irrespective of the amount paid. Pensions and lump sums paid from an SMSF to those who are 60 or older and qualify are tax-free. Where an SMSF does not meet the SISA requirements, the trustees may be exposed to a range of penalties including disqualification as a trustee of any fund or the fund may be taxed as a non-complying superannuation fund. The tax rate for a non-complying superannuation fund is 45% for the 2020/21 financial year on its taxable income and certain assets of the fund in the financial year in which the fund is made non-complying. In subsequent years in which the fund remains non-complying, the income and taxable capital gains are taxed at the maximum rate which for the 2020/21 financial year is 45%.

¶5-020 What is an SMSF? An SMSF is a superannuation fund with fewer than five members, where the members actively participate in the fund’s management. The 2018 Federal Budget included a proposal to increase the minimum number of members of an SMSF to six members. At the time of writing, this remains under consideration by the government. As a general rule, the member (or members) of the SMSF is the trustee (or trustees) of the fund or

directors of a company that is trustee of the fund. The trustees of the SMSF have full responsibility for the fund’s management, investment and general administration functions, usually with the assistance of external service providers. The term “self managed superannuation fund” is defined in s 17A of the SISA and requires the superannuation fund to satisfy the following basic conditions: • The fund must have no more than five members (including pensioner members) under the current rules; however, this may increase to a maximum of six members. To be considered a member of an SMSF a member must have a beneficial entitlement in the fund such as a right to a lump sum or pension or insured benefit. • All members are individual trustees (or directors if a corporate trustee) and there are no other trustees, unless the fund has only one member or a member is under a legal disability. • Members of the fund are not permitted to be an “employee” of another member (or associate) unless they are “relatives” of another member (“employee” and “relative” are defined below). In comparison to other types of superannuation funds, trustees of SMSFs are prohibited from receiving remuneration for their duties or services as trustee. However, it is possible for the trustee or director of the trustee company to be remunerated on arm’s length terms for work carried out for the fund for which they are appropriately licensed or qualified. The type of work undertaken for the fund must be for work the person would ordinarily perform for members of the public (s 17B of the SISA). Example Sam is a plumber and his wife Nancy is an interior decorator. They are both trustee/members of their SMSF which owns a rental property. Sam is able to be paid at his normal commercial rates by the fund for any plumbing work he undertakes on the property. However, Nancy, although she is very good at house painting, could not be paid for any work she did when she painted the rental property. It is possible that the work she does on the property owned by the fund and for which she does not receive remuneration could be treated as a contribution to the fund (refer to Taxation Ruling TR 2010/1 on “What is a contribution to a superannuation fund”).

SMSFs have special rules where the fund has only one member due to the operation of the law of trusts. Under that law a valid trust does not exist where it consists of a single individual trustee who is also the only beneficiary of the trust. Where a fund has only one member it is possible to have an additional trustee or director of a corporate trustee who is not a member. The rules for single member funds are as follows: • if the fund has a corporate trustee, the member must: – be the sole director, or – be one of two directors and not an employee of the other director (unless a relative) • if the fund has two individual trustees, the member must: – be one of the trustees – not be an employee of the other trustee unless the other trustee is a relative, and • no trustee receives remuneration for any duties or services as trustee of the fund or other duties and services unless those services are provided on arm’s length terms for which the trustee is licensed or qualified. Who is a relative? A relative of an individual is: • a parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant or adopted child of the individual or of their spouse

• a spouse of the individual or of any other individual mentioned above. The definition of spouse includes all married couples (opposite-sex and same-sex) and a person who lives with the person on a genuine domestic basis as the husband or wife of the person. A child includes a child of a member of a same-sex couple. The following flow chart should assist to determine who is a relative.

Employment relationships The term “employee” of a person includes not only the meaning under common law but also is deemed to include a member employed by another person who is associated with the fund’s employer-sponsor. A person will be deemed to be employed by another person if the employer-sponsor is: • a relative of the other person • a company or a related company of which the other person or a relative of that person is a director • the trustee of a trust of which the other person or a relative of that person is a beneficiary • a partnership where: – the other person or a relative of that person is a partner – the other person or a relative of that person is a director of a company that is a partner in the partnership, or – the other person or a relative of that person is a beneficiary of a trust, the trustee of which is a partner in the partnership, or • a person specified by the SIS Regulations (SISR) to be an employee. The meaning of “employee” for the definition of an SMSF also provides a member who is a director of an employer-sponsor company will not be considered an employee of that company — as a consequence they will also not be considered an employee of any other director of that company. As a result, they will be allowed to be members of an SMSF together, assuming that the other requirements for an SMSF are met. In addition, a member is deemed not to be an employee of another person (not a relative) if that member

is an employee and a relative of another member. Example Rex operates his electrician’s business via a company structure. The company employs his cousin, Alan and a person to whom he is not related, Ross. If Rex commenced an SMSF for his business, he could only have Alan and himself as members of the fund. Ross could not become a member of the SMSF as he is an employee of Rex’s company and is not a relative.

Company trustee There were about 60.6% of all SMSFs as at 30 June 2019 that had a company as a trustee. The main reasons for having a corporate trustee relate to the clear identification of the fund’s investments and reduced administration if there is a change of directors. As the investments of the fund will be in the name of the corporate trustee, there is no need to change the ownership of the investments which would be the case if there was a change of individual trustees. The individual trustees would be required to notify various registries where there is a change. There are about 39.4% of all SMSFs that have individual trustees. It is interesting to note that about 81.6% of newly established SMSFs have a corporate trustee with 18.4% of new SMSFs with individual trustees. Example Ron and Jan are individual trustees of their SMSF. Bruce and Jenny are directors of a company which is trustee of their SMSF. During the year both SMSFs have one of their adult children join the SMSF. It will be necessary for Ron and Jan’s SMSF to notify the fund’s bank(s) and relevant registers of the change to fund trustees. This may include the share registries, land titles offices and other investment bodies. In contrast it will not be necessary for Bruce and Jenny’s SMSF to notify the share registries, etc because the ownership of the fund investments continues to be in the name of the corporate trustee. However, they will need to notify the Australian Securities and Investments Commission (ASIC) of the change in directors of the company.

Clear identification of the ownership of the investments of an SMSF is necessary under SISA to ensure creditors are unable to make a claim over a fund investment where a trustee or member is insolvent. This should be supported by minutes, banking records and relevant proof of ownership. Example Manuel Fawlty and his partner Marcello are individual trustees of their SMSF. Manuel has some fund investments recorded in his name and some in joint names; however, this has not been adequately recorded in the records of the superannuation fund. If Manuel was to become insolvent, creditors may have a claim on the investments held in his name. This is apart from the compliance issues that may arise and penalties that could apply with the fund not keeping adequate books for purposes of the SISA.

Another less obvious reason for preferring a corporate trustee is the operation of the SISA. Under s 19 of the SISA, a superannuation fund is required to have a trustee. The trustee must consist of either a corporate trustee or the governing rules of the fund must provide that the sole or primary purpose of the fund must be to provide “old age” pensions. These provisions are significant as they enable the federal government to regulate superannuation. Under these provisions, if the fund trustee is a company it is possible for the fund to pay lump sums and/or pensions if permitted by the governing rules, for example, the fund’s trust deed. However, if the trustees are individuals, the fund must have a requirement that it pays pensions. It is also permissible for funds which have individuals as trustees to pay lump sums. From a financial planning perspective, it is important to recognise the types of benefits that can be paid under the governing rules of a superannuation fund. Another reason for having a corporate trustee is that if a member leaves the fund in an event such as transferring benefits to another fund, retirement, death or divorce, there is no requirement under SISA to appoint a second director to the company. An amendment to the company’s constitution may be required to have a single director. In the case of individual trustees, there must be at least two trustees at all times. In the event of a member’s death, a legal personal representative may be appointed as a trustee on

behalf of the member but only until the deceased member’s lump sum or pension benefits have commenced to be paid (s 17A(3) of the SISA). Example Ruth and her partner Ted are members of an SMSF which has a corporate trustee. They separate and Ted decides to transfer his benefit to another superannuation fund. From that time Ruth will be the sole director of the corporate trustee which is acceptable under the SISA. However, if Ruth and Ted were individual trustees of their SMSF, a second trustee who is not a relative and not Ruth’s employer or her employee could be appointed to the fund. There is no requirement for the second trustee to be a member of the fund.

Exceptions to the rule for trustees and directors The SISA requires all members of an SMSF to be trustees; however, these rules are modified in circumstances where a member does not have legal capacity to act as a trustee. This occurs where a person is under age 18 or is unable to manage their affairs because of disability or incapacity. In these circumstances, the SMSF will continue to meet the definition in the SISA where the member’s legal personal representative, parent or guardian acts as a trustee or director of the corporate trustee for the child. A further exception is provided where a person has an enduring power of attorney in respect of a member of the fund. That person may become the trustee of the fund or director of the corporate trustee in place of the member being the trustee or director of the corporate trustee. This may be appropriate where a member or members of a fund may be temporarily overseas for a period of more than two years as the fund may not be able to satisfy the definition of an Australian superannuation fund. It should be ensured that in all cases the power of attorney is effective under the relevant state legislation, otherwise the power of attorney may be ineffective in allowing the attorney to be the fund trustee. The use of enduring powers of attorney for a member of an SMSF is discussed in Self Managed Superannuation Fund Ruling SMSFR 2010/2. Example Mike and Sharon are trustee/members of their SMSF. They go overseas to work for an undetermined time. They decide to execute an enduring power of attorney in relation to their financial affairs and allow Mike’s brother, Chris to be the trustee of their superannuation fund. Under state legislation, the power of attorney may be effective from the date of its execution. In order for Chris to be the trustee of the fund, Mike and Sharon need to resign as trustees of their SMSF, and Chris will then be appointed as the trustee of the fund during their absence. As Chris remains in Australia and he has the power under the fund’s trust deed to make decisions in relation to the fund, central management and control will be in Australia. Once Mike and Sharon return to Australia permanently, Chris will resign as trustee and they will take over as fund trustees again. An alternative to appointing a person who holds an enduring power of attorney as trustee could be to accept Chris as a trustee and member of the fund. The trust deed would also need to provide Chris with the power to make decisions for the fund. This would allow the fund to operate effectively while Mike and Sharon are overseas without need to grant an enduring power of attorney to Chris.

Although s 17A makes exceptions to the general rule for trustees, if the governing rules of the fund do not allow a legal personal representative, parent, guardian or person with an enduring power of attorney to be a trustee or director of the trustee company, it cannot be done. Likewise, if there is a corporate trustee, there must be a power allowing the appointment of a director in the circumstances. Application on death The legal personal representative of a deceased member (the executor or administrator of the member’s estate) is permitted to act as a trustee or director of the corporate trustee without the fund breaching the definition of an SMSF. There is no strict requirement for the deceased’s legal personal representative to do so. Also, there are limits as to how long the deceased’s legal personal representative may remain a member. The duration specified in the SISA commences from the date of the member’s death and ceases at the time death benefits commence to be paid. The governing rules of the fund must allow an executor to take the place of the member as trustee of the fund or as director of the corporate trustee. The rules of the trustee company may also limit the duration

of the legal personal representative acting as a director. In the governing rules of some funds, the legal personal representative takes the place of the deceased automatically which helps to ensure the interests of the deceased are achieved. An interesting case in this area is Katz v Grossman 05 ESL 17; [2005] NSWSC 934. Example Vance and Margaret are members of an SMSF which has a corporate trustee. Vance dies in a car accident. Under the provisions of the SISA, it is possible for Vance’s legal personal representative to be appointed as a trustee in his place until his benefits commence to be paid. However, after that the legal personal representative is required to resign as trustee. From that time, Margaret will be the sole director of the corporate trustee which is acceptable under the SISA. However, if Vance and Margaret were individual trustees of their SMSF, after the legal personal representative has resigned as trustee from the fund a second trustee is required to be appointed or a corporate trustee could replace the individual trustee.

Penalties Where the fund does not meet all the requirements of the definition of an SMSF, the trustees must notify the ATO of the change in status within 21 days. Failure to do so renders the trustee potentially liable to a fine of $11,100 (50 penalty units). Each penalty unit equates to $222 from 1 July 2020 (indexed every three years). If the trustees of the fund do not resign and appoint an appropriate trustee within six months of the fund failing to meet the definition of an SMSF, the penalty for the trustees is up to six months’ imprisonment. There is no discretion available to the ATO to overlook the failure of the fund to meet the definition of an SMSF; it is a penalty of strict liability. Additionally, it is a penalty that may apply to the adviser if they have aided or known the fund was no longer an SMSF and did not advise the trustees to resign and appoint an approved trustee. Since 1 July 2014, a range of penalties for SMSFs, in addition to the ATO’s other enforcement powers under the ITAA97 and SISA, can be imposed by the ATO for breaches of some of the operating standards. These penalties allow the ATO to: • issue a rectification direction • issue an education direction • impose an administrative penalty. Rectification direction A rectification direction can be imposed if the ATO reasonably believes that a contravention has occurred and to direct the trustee to take action to rectify the breach within a specific time. This may include a direction that arrangements be put in place to prevent further breaches from occurring. In imposing a rectification direction, the ATO is required to have regard to the financial detriment of the penalty, the seriousness of the contravention and other circumstances relating to the contravention. If a rectification direction is made by the ATO, it must be satisfied within a specified time and evidence of the rectification must be produced. If the direction is not satisfied, then a strict liability offence has occurred and the trustee(s) is liable to a penalty of $2,220 and may result in the ATO seeking more stringent sanctions on the fund trustees or the fund. Education direction An education direction can be imposed if the ATO reasonably believes that the trustee is unaware of the rules or the contravention of the SISA is a first-time event. The direction can require the trustee to attend an ATO-approved course which is required to be free of charge. Once the course has been successfully completed, evidence of completion is required and the trustee is required to sign a trustee declaration that they understand the operation of the rules relating to the fund. The ATO has indicated that it would be unlikely to give an education direction if the fund had contravened SISA in a prior year or the trustees were required to be previously advised of the rules. In those cases, it would be likely that the ATO would issue a rectification direction, impose an administrative penalty or

consider imposition of another penalty under the SISA. Administrative penalty Administrative penalties ranging from $1,110 to $13,320 from 1 July 2020 may be imposed by the ATO for certain breaches of the SISA. Examples of the maximum penalty include contraventions of the rules relating to the fund lending, borrowing or in-house assets. Examples of the minimum penalty include contraventions of undertaking a course as part of an education direction or providing information in the form approved by the Commissioner. When considering imposition of the penalty, the ATO would take into account the previous contraventions of SISA by the fund, whether steps have been taken to rectify the contravention and there are no circumstances present to warrant the remission of the penalty. When a contravention has occurred, the fund is liable for the whole penalty applying to the breach rather than a penalty which is less than the maximum depending on the circumstances. Where the contravention has been rectified or other circumstances are present, the ATO may remit the penalty. If a penalty is imposed, it is not possible for the ATO to use a rectification direction in conjunction with other sanctions such as an enforceable undertaking that has been previously accepted by the trustee in relation to the same contravention. However, this does not stop the ATO concurrently imposing a rectification direction and administrative penalty in relation to the contravention. The cost of a penalty is borne by each individual trustee or by the corporate trustee and cannot be paid or reimbursed from the money or assets held by the SMSF.

¶5-040 Benefits of SMSFs The advantage of having an SMSF is based on the following main elements — investment choice and control, flexibility, taxation benefits and costs. A client may forgo the advantage of one of these elements to gain advantage to one or more of the others. As a rule of thumb, it is considered that an SMSF with investments of less than about $200,000 may not be cost-effective. The reason is that at less than that amount, the costs of operating an SMSF are greater than the cost of investing through other superannuation arrangements. In some cases there may be reasons for having an SMSF where assets are less than $200,000. These could include that the fund will build to $200,000 or more within a short time, specialised investments or the value of assets of the fund has decreased because of benefit payments. However, trustees would need to take into account all of the circumstances surrounding the establishment of the SMSF. The control offered by SMSFs, together with the relatively low tax rate, makes them very attractive to many but also create a temptation to engage in risky strategies. The ATO, as the regulator of SMSFs (¶5100) has developed the Super Scheme Smart, aimed at educating individuals and advisers about the potential pitfalls of some retirement planning schemes being implemented by a small number of SMSFs, as well as publishing characteristics of specific schemes it is monitoring. ASIC has released two information sheets, INFO 205 Advice on self managed superannuation funds: Disclosure of risks and INFO 206 Advice on self managed superannuation funds: Disclosure of costs which are designed to assist advisers in their conduct and disclosure obligations under the Corporations Act. The information sheets specify the types of risks and costs an adviser should consider, discuss and then disclose to clients when providing advice on establishing or switching to an SMSF. In terms of the cost-effectiveness of SMSFs, ASIC’s view is that where an SMSF has assets of less than $200,000 an adviser should be able to justify the reasons for recommending an SMSF to the client. Any advice which recommends establishing an SMSF below that threshold is more likely to be scrutinised by ASIC. (1) Investment choice and control The major reason for establishing an SMSF is the control the trustees and members have over investments and investment decisions. Many trustees of SMSFs prefer to invest directly by purchasing shares, units in unit trusts and managed funds, interest bearing securities and real estate as they consider their decisions can produce better returns than professional superannuation fund managers.

SMSFs are in a unique position as they are able to acquire certain investments from members which are not available to funds with five or more members. For example, a superannuation fund with less than five members can acquire business real (commercial) property from members and other related parties. This can provide a number of taxation advantages for a client who is able to transfer commercial property they own to the SMSF. Prior to the transfer, the trustees would need to ensure the other investment standards in the SISA are satisfied, for example, that the property is “business real property” as defined in s 66 of SISA and discussed by the ATO in SMSF Ruling SMSFR 2009/1. It is possible for the fund to acquire a property that is subject to a mortgage or charge as discussed in ATO Interpretative Decision (ATO ID 2011/81). However, in practice the lender (mortgagor) may not approve the transfer of the mortgage as there would be a change of owner (mortgagee). In addition to the SMSF investing directly, it is possible for the fund to purchase an asset via a limited recourse borrowing arrangement. This permits the fund to borrow for the purposes of the arrangement providing the asset is one that the fund could acquire and it is held on trust until the loan has been extinguished. In response to certain practices that developed concerning limited recourse borrowing arrangements, the ATO has published some safe-harbour guidelines on what they consider constitutes a commercial arm’s length loan. An example of what is not commercial was interest-free loans which were made to the superannuation fund. Interest-free loans are discussed in ATO Taxation Determination TD 2016/16. This determination led to the publication of Practical Compliance Guideline PCG 2016/5 which provides safeharbour guidelines for low or no interest limited recourse borrowing loans for LRBAs. In addition, the non-arm’s length income provisions of the Income Tax Assessment Act 1997 (ITAA97) were amended and backdated to 1 July 2018 to tax income as non-arm’s length income where the net income, after expenses, was considered to be not on an arm’s length basis. (2) Investment flexibility An SMSF has the flexibility to buy and sell investments to take advantage of market timing based on the trustee’s judgment. This may permit the trustees to obtain greater returns for the fund based on different investment time horizons used by the larger funds. The timing of the purchase or sale of the asset may provide some advantages for purposes of taxing any capital gain. (3) Tax efficiency SMSFs are treated for tax purposes under the income tax law exactly in the same way as all other superannuation funds. However, the way the tax rules are used can provide efficiencies for the fund. Tax efficiencies can be obtained from the control and flexibility over investments so that buying and selling can be timed to maximise the best tax outcomes for the fund. For example, by changing the timing of income and expenses the overall tax position of the SMSF may change. This may occur where a fund moves from accumulation to retirement phase. In retirement phase the income and capital gains on pension assets, except for transition to retirement income stream (TRIS) assets that are not in retirement phase, are tax-free in the fund. Therefore, if a member of the SMSF is to commence a pension, it may be worthwhile deferring sale of an investment which has a potential taxable capital gain if it is to be used to provide pensions to members. (4) Cost advantages One of the reasons people consider an SMSF beneficial is the potential cost advantages that can be obtained. All relevant information should be obtained about the operation of the SMSF and any funds which are considered as alternatives. If the client decides to undertake some of the functions of the SMSF, then this should be taken into account in calculating the costs of running the fund. Costs may not be the only reason of having an SMSF. The control and flexibility over investments may be more important to the trustees. (5) Estate planning SMSFs can provide an effective estate planning vehicle. By introducing younger generations as members of an SMSF and with prudent contribution strategies, it may be possible to build up the fund to provide

cash benefits for older generations and preserve assets used in the family business, such as real estate. (6) Creditor protection SMSFs are able to provide protection from creditors for those assets which may be leased to related parties of the fund. This applies to business property or certain in-house assets which can be owned by the fund and as a general rule cannot be accessed by creditors of the fund members. Larger funds usually do not permit the lease of fund property to members or related parties which is permitted in SMSFs. There is no limit to the amount that can be held in the fund and protected from creditors. As a consequence, the bankruptcy legislation has been strengthened to ensure that amounts transferred into superannuation with the aim to defeat creditors can be accessed (¶4-160). (7) Access to the Age Pension Receiving a lifetime, life expectancy or market-linked pension from an SMSF provides trustee/members of SMSFs with investment control and flexibility and access to certain Centrelink concessions. There are different types of pensions which provide favourable treatment for Centrelink purposes, depending on the time they commenced. Lifetime and life expectancy complying pensions that commenced prior to 20 September 2004 are fully assets test exempt at all times. These pensions were used almost exclusively by SMSFs as they also provided advantages under the income tax law as it existed up until 30 June 2007. Lifetime and life expectancy complying pensions and market-linked income streams that commenced between 20 September 2004 and 19 September 2007 are 50% assets test exempt. This was the main reason for members of SMSFs commencing lifetime and life expectancy pensions in an SMSF. Due to changes in the legislation, it has not been possible to commence a lifetime or life expectancy pension from an SMSF since 31 December 2005. In some cases, a solvency issue may arise with a lifetime or life expectancy complying pension due to investment volatility. If the pension has a solvency issue, the fund actuary may require that it is commuted and rolled over to commence another complying pension, for example, a market-linked income stream with the relevant SMSF or a lifetime or life expectancy pension with an insurance company. It is worthwhile to check with Centrelink to determine whether the assets test exemptions or partial exemptions will continue to apply on commutation or rollover of the lifetime or life expectancy pension. Superannuation pensions that commenced on or after 20 September 2007 do not have access to exemptions from the assets test with the exception of the deductible amount. However, assets test exempt and partially exempt pensions which commenced prior to that time continue to receive the relevant exemption. To offset this change, the upper threshold at which the assets test phases out was increased. Pensions that commenced prior to 20 September 2007 that received Centrelink concessions can be commuted and rolled over to commence an equivalent pension providing additional amounts are not used to commence the new pension. For example, it is possible to commute a market-linked income stream and roll it over to commence a new market-linked income stream while retaining the same level of Centrelink concessions. Account-based income streams that commenced on or after 1 January 2015, or have been modified or stopped after that date, are treated as financial investments for income and assets test purposes. In addition, the capital value of the income stream is subject to deeming just like any other type of financial investment. As a general rule, there is no change to account-based pensions that commenced prior to 1 January 2015 as the calculation of the deductible amount continues. However, a pension in existence prior to 1 January 2015 can be subject to deeming if a person, for example, was in receipt of an income support payment and the payment ceases for any reason from 1 January 2015. However, in some cases where there are higher drawdown rates of the account-based income stream, deeming may result in a better outcome.

¶5-050 Obligations on SMSF trustees SMSFs are recognised as having a number of significant advantages based on the control and flexibility

trustees have in the overall management of the fund. However, along with the benefits comes a range of obligations. These obligations include responsibilities imposed on trustees under the trust law, trust deed, governing rules, the Corporations law and the SISA to name a few. (1) Trust deed and governing rules The trust deed and other governing rules of the superannuation fund set out the rights and obligations of those parties who are connected with the operation of the superannuation fund. This includes the trustees, members and anyone who has a right to a benefit from the fund. (2) Trustee liability An SMSF is required to be constituted as a trust, which means the fund is subject to the trust legislation of the various states. However, this law is generally disregarded where a provision of a trust deed governing the fund prevails. In addition to the trust law, the SISA places obligations on trustees so that the fund gains access to tax concessions. Many of these provisions are included or deemed to be incorporated in the governing rules of the fund. Trustees of SMSFs are personally liable for any decisions made in relation to the operation of the fund. In some circumstances trustees may be required to compensate an injured party personally for any reckless behaviour and may be personally penalised for any breaches of the legislation. Superannuation legislation places the same responsibilities on directors of the corporate trustee as it does on individual trustees. Since 1 July 2014, a system of additional penalties has applied to SMSFs. Trustees are personally liable for any penalty that is able to be imposed directly by the ATO. Penalties may be imposed on each individual trustee, however, in the case of a corporate trustee only one penalty is imposed on the company for which the directors are jointly and severally liable. (3) Administration The SIS legislation requires that all superannuation funds maintain appropriate books and records. In the case of SMSFs, because of the relationship between the trustees and members, it may be more important to ensure that the fund records are meticulous. This would apply where the SMSF conducts transactions on a non-arm’s length basis or has a large number of transactions. In some cases a third party may incur expenses on behalf of an SMSF and there is a need to ensure these transactions are correctly recorded. The circumstances in which an expense may be treated as a contribution is discussed in Taxation Ruling TR 2010/1 or in some cases the expense may be treated as a borrowing by the fund as discussed in SMSF Ruling SMSFR 2009/2. Some trustees choose to use an external SMSF administration service or their accountant to undertake the fund administration. (4) Costs It is usual to find that the costs of running an SMSF are proportionately higher for a fund that has smaller balances. Where this is the case the costs may outweigh the benefits of having an SMSF. As a general rule it is considered that SMSFs should have a minimum superannuation balance of at least $200,000 in accumulation phase to be cost-effective and possibly a higher amount when the fund is in the pension phase. There may be circumstances in which it is valid to have a fund with total balances of less than the amount which were explained previously. (5) Time A trustee of an SMSF may need to set aside time for the ongoing management of the fund if it is decided to undertake some of the administration functions themselves. Although trustees have a degree of control over the level of their involvement, it will still be greater than if the superannuation was invested with a large publicly offered superannuation fund. Even though the fund accountant and financial planner may provide the ongoing advice in relation to the fund, the advice must nevertheless be considered by the trustees who are ultimately responsible for all fund decisions in their capacity as trustee. (6) No access to Superannuation Complaints Tribunal/Australian Financial Complaints Authority

Trustees and members of superannuation arrangements which are regulated by APRA have access to the Australian Financial Complaints Authority (AFCA) which replaced the Superannuation Complaints Tribunal (SCT), Financial Ombudsman Service, and the Credit and Investment Ombudsman from 1 November 2018. SMSFs do not have access to AFCA, and any dispute may need to proceed via the courts or an alternative dispute resolution arrangement. In some cases it may be possible for the trustee to seek compensation where incorrect or inappropriate advice has been provided by a licensed financial planner. The manner in which a dispute is to be settled may also be included in the trust deed or other governing rules of the SMSF. Complaints about SMSFs are excluded from being made under the AFCA on the basis that all of the trustees of an SMSF are required to be members. There remains a limited avenue of appeal to the Federal Court on points of law, although this can be costly. As a consumer of financial advice, an SMSF may lodge a [non-superannuation] complaint with the AFCA. Where the relationship between the trustee/members of an SMSF breakdown, irreconcilable differences may arise regarding the operation of the SMSF. Without access to AFCA an alternate external dispute resolution (EDR) scheme, such as arbitration, will require consideration. (7) No access to government financial assistance Members of SMSFs are not eligible for the grant of government financial assistance under Pt 23 of the SISA that may be provided for funds that have suffered a loss as a result of fraudulent conduct or theft. The reason is that as the trustees of an SMSF are also members of the fund they are able to control their own destiny. (8) Penalties Where the trustees of an SMSF have acted recklessly in relation to the fund, the fund may be taxed on its income as a non-complying fund at a penalty tax rate of 45% for the 2020/21 financial year. The trustees may also be penalised under the civil and criminal penalty provisions of SISA and can be disqualified from acting as a trustee of any superannuation fund. The case of Hart v FC of T 18 ESL 05; [2018] AATA 1267 is interesting as it involves the disqualification of a trustee. The ATO is able to impose new penalties on trustees or directors of the trustee company, including administrative penalties, education directions and rectification directions for SMSFs.

¶5-060 Federal Budget proposed changes to SMSFs The 2018 Federal Budget proposed the following changes to SMSFs: • An increase in the maximum number of SMSF members (or small APRA fund) from four to six. • Introduction of a three-year audit cycle for SMSFs with good compliance track records. From 1 July 2019, if an SMSF is well-behaved (history of good record-keeping and compliance, clear audit reports for three years, and lodged returns on time), SMSF trustees of such a fund will meet compliance requirements by having an SMSF audit every three years. • An increase in the supervisory levy for SMSFs from 1 July 2018 which is included in the proposal to provide full cost recovery of ATO superannuation activities. This is designed to raise additional revenue to fully recover the cost of superannuation activities undertaken by the ATO. At the time of writing, the legislation remains under consideration by the government.

ESTABLISHING AN SMSF ¶5-100 The basic requirements to establish an SMSF A number of trust law and legislative requirements must be complied with when establishing an SMSF. Many professional advisers and superannuation providers, such as accountants, solicitors and superannuation administration specialists, provide “packages” to simplify the process.

In broad terms and in no particular order, establishing a fund should cover the following matters: • the appropriateness of the SMSF to the member’s circumstances • obtaining a suitable and up-to-date trust deed • obtaining the person’s consent to act as trustee or director of the corporate trustee of the fund including a declaration that there is nothing disqualifying the person from acting as a trustee or a director of a corporate trustee • holding the first meeting of trustees • deciding on a name for the fund • electing to be a regulated superannuation fund under SISA • applying for a TFN, Australian Business Number (ABN) and possibly registering for goods and services tax (GST), for the fund • drafting or obtaining a suitable Product Disclosure Statement (PDS), if required, which will be provided by the fund’s financial adviser, lawyer or administrator as part of the package to establish the SMSF • obtaining applications for membership of the fund • obtaining member details and TFNs • opening a bank account in the trustee’s name(s) as trustee for (ATF) the fund, and • making the first contribution to the fund or settlement amount. Some key procedural and tax issues to be considered in the establishment process are discussed below. Trust deed An executed fund trust deed (¶5-310) and other governing rules of the fund (assuming they refer to trustee’s rights, obligations and other important matters) can be evidence that the fund has been established as a trust. Among other things, the trust deed will usually set out: • who can be a trustee • the rules for appointing and removing trustees • the decision-making powers of trustees • who can be a fund member • who can make contributions • when benefits are payable to members, and • procedures for termination and winding up of the fund. A solicitor or legal service company may prepare the trust deed. It must be correctly drafted and contain the appropriate clauses to enable the fund to achieve its objectives. For example, the trust deed should enable acceptance of the government’s co-contribution, low income superannuation tax offset, superannuation spouse contributions splitting, refund of contributions where required under the superannuation law, payment of amounts in relation to excess contributions tax and excess transfer balance cap amounts as well as the particular types of pensions authorised by the legislation and other recent changes, for example, the commencement of the downsizer contribution which commenced from 1 July 2018.

The deed must be signed by the trustees, dated and properly executed in accordance with the relevant state laws. It is vital the trust deed is understood by the adviser and trustees. A breach of the deed or other governing rules of the fund may render the adviser or trustees liable for compensation to the injured party and may expose them to various penalties under the SISA. Becoming a regulated superannuation fund To qualify as a superannuation fund regulated by SISA, the trustee must make an irrevocable election which is lodged with the ATO. Once the election is made the SMSF is subject to SISA. It is treated as a complying superannuation fund and eligible for concessional tax treatment. The election must be lodged with the ATO by completing an ABN registration for superannuation entities form which is available on the ATO website (www.ato.gov.au) within 60 days of the establishment of the fund. This form is also used by the ATO to register funds for ABN purposes. Since 1 January 2015, the ATO has taken a much stricter approach in vetting funds that have applied for registration. As part of the processes put in place by the ATO, trustees must establish they are considered competent to be trustees of the fund and that a valid superannuation fund is in existence which requires that, at least, a nominal amount, say $100, is held by the fund to satisfy the ATO requirement that a valid trust has been established. This could be the first contribution to the fund, for example. Under s 104A of the SISA, it is necessary for new trustees or directors of a corporate trustee of any SMSF to sign a trustee declaration. The declaration is a pre-printed document which is available from the ATO. By signing the declaration, the trustees have acknowledged they are aware of their rights and obligations under SISA. The declaration should be kept as part of the fund records as there is no requirement to send it to the ATO unless specifically requested. Obtaining a TFN and ABN A TFN is a unique number issued by the ATO for each taxpayer. The trustees of an SMSF must obtain a TFN for the fund. Superannuation funds are allocated a TFN after lodgment of the ABN registration for superannuation entities form referred to above. The ABN enables businesses and other entities to be readily identified at all government agencies. It is also allocated to superannuation funds which lodge an ABN registration for superannuation entities form. Obtaining a TFN for an SMSF is vitally important if a member of the SMSF wishes to transfer benefits from another superannuation fund. If an SMSF has not obtained a TFN and a member wishes to transfer benefits from another fund, the amount to be transferred will be subject to tax at 47% for the 2020/21 financial year. This situation should be avoided. It would be unusual that an SMSF does not have, or is not permitted to use, the member’s TFN. If a member’s TFN has not been obtained by the fund, the trustee may be prevented from accepting certain types of contributions or, if the contribution can be accepted, it may be taxed at penalty rates of up to 47% for the 2020/21 financial year. If a member’s account was opened prior to 1 July 2007 and employer contributions of more than $1,000 and a TFN has not been recorded by the end of the financial year in which the contribution was made, then it will be taxed in the fund at 47% for the 2020/21 financial year. For member accounts opened on or after 1 July 2007 and a TFN has not been quoted, then employer contributions will be taxed at the rate for the superannuation fund of 15% plus an extra 32% for the 2020/21 financial year. A fund trustee is obliged to reject personal and spouse contributions where the fund has not recorded the relevant TFN. Where a member’s TFN has not been obtained by the fund, the trustee may not be permitted to accept the contribution. In some cases, certain contributions may be taxed at penalty rates. Also, where employer contributions of more than $1,000 have been made to the fund on or after 1 July 2007 and a TFN is not recorded for the member by the end of the financial year, it is taxed in the fund at 47% for the 2020/21 financial year. It is possible for the fund to obtain a tax offset for the additional tax paid where a TFN is quoted within the three most recent years of the TFN quotation. Commencing fund operations

Once an SMSF has been established and a trustee(s) has been appointed, the fund can commence its normal operations of accepting contributions, investing the assets of the fund and setting up the administration arrangements. Section 118 of the SISA requires a person to consent to their appointment as a trustee of a superannuation fund or director of a corporate trustee.

¶5-110 Duties of SMSF trustees The trustee of an SMSF is subject to various duties. These duties arise under: • the general trust law • statutory law — principally SISA, the Trustee Act of a state or territory and income tax laws, and • the superannuation fund trust deed or governing rules. The consequences for a trustee who fails to act in accordance with these duties depend on the particular duty that is breached. For example, if the duties breached are those under the SIS legislation, criminal or civil action may be taken against the trustee. As a consequence, a fine or term of imprisonment may be imposed on the trustee and, in addition, the fund may be found to be a non-complying fund and lose its concessional tax status. On the other hand, if a trustee fails to act in accordance with the trust deed, an action under s 55(1) of the SISA as well as a breach of trust may be brought against the trustee by the affected members. An interesting case on s 55 is Dunstone v Irving 00 ESL 22; [2000] VSC 488. The trustee of an SMSF must be familiar with the common law or statutory duties and, when in doubt, should not hesitate to seek professional advice. Any provision in the fund’s trust deed that prevents the trustee from seeking advice in relation to performance of the trustee’s duties or powers, or from being indemnified out of the fund’s assets in respect of the costs of obtaining such advice, is void. Some of the duties of a trustee deal with the three principal areas of fund operations, namely: • acceptance of contributions • investment of funds, and • payment of benefits, whether in a lump sum or as an income stream. The fund’s trust deed, the general trust law and other statutory requirements must also be considered. It is possible, for example, for a fund’s trust deed to provide more restrictive rules than the SIS legislation. Overlap of SIS covenants and trust law duties SISA contains covenants that reflect some of the duties imposed on a trustee under general trust law. The covenants codify some of the more common duties on trustees and are deemed to be included in the trust deed of every regulated superannuation fund. Broadly, the covenants bind trustees to: • act honestly in all matters • exercise the same degree of care, skill and diligence as an ordinary prudent person • act in the best interests of the fund members • keep the assets of the fund separate from other assets (eg the trustee’s personal assets) • retain control over the fund • develop, implement and regularly review the fund’s investment strategy, and • allow members access to certain information. Delegation of responsibilities to service providers In the course of the fund’s operation, the trustee may engage service providers to perform certain

functions on their behalf (eg an accountant, fund administrator, tax agent, lawyer). However, it is important to remember that the trustee is the responsible entity under SISA, and has ultimate responsibility and accountability for ensuring that the fund is managed and operated in a prudent manner. Keeping fund assets separate The trustees of an SMSF must keep money and other assets of the superannuation fund separate from their own personal assets and from the assets belonging to a business (eg a business run by two partners who are members of an SMSF). The money and assets belonging to the fund must not, under any circumstances, be used for personal or business purposes as this will, in most cases, breach the sole purpose test and the rules governing the investment of fund assets. Under SISR reg 4.09A, trustees must keep the assets of the superannuation fund separate from their personal or corporate assets. If this standard is not met, it allows the ATO to impose penalties for noncompliance. The requirement to keep assets of the fund separate is discussed in ATO ID 2014/7. Residency status of the fund The provisions of Div 295 of the ITAA97 provide tax concessional status to the income of a complying Australian superannuation fund. Where a fund fails to meet the residency requirements, it will be taxed as a non-complying fund at a tax rate of 45%. In the first year that a regulated fund is taxed as a noncomplying fund, tax is payable on any income earned during the relevant year plus the value of the fund’s assets at the commencement of the year. The crystallised part of the non-concessional contributions that relate to the period after 30 June 1983 and non-concessional contributions are excluded from the value of the fund’s assets. It is for this reason that trustees must ensure the fund is treated as a complying fund and taxed at the concessional rate of up to 15% on the income and realised capital gains earned by the fund during the year of income. To remain a resident superannuation fund, an SMSF must meet the superannuation fund residency requirements (¶4-600). There are three requirements that must be met: • the fund establishment test — that the fund was established in Australia, or any asset of the fund is situated in Australia at that time • the central management and control test • the active member test — that at least 50% of benefits of members for whom contributions have been made relate to Australian residents. A person is an active member of the fund if the member is a contributor of the fund at that time or another person has made contributions on that person’s behalf in that financial year. A person is not an active member if the member is not a resident and no contributions have been made for the member or the member has ceased to be a contributor to the fund, and the only contributions that have been made, were made when the member was a resident. The active member test is assessed independently of the central management and control test (s 295-95(4) of the ITAA97). The definition of “Australian superannuation fund” requires the central management and control of the fund to be ordinarily in Australia. However, it treats a fund as having its central management and control in Australia although the trustees may be temporarily absent from Australia for up to two years. Taxation Ruling TR 2008/9 provides the ATO’s interpretation of the meaning of an Australian superannuation fund. Example Brad and Janet are members of an SMSF. Brad’s balance in the fund is $100,000 and Janet has a balance in the SMSF of $200,000. Brad is transferred overseas to work for up to two years. During that time he wishes to make a contribution to the fund. If Brad was the only contributor to the fund during the year, he would be the only active member and therefore the fund would fail the 50% test for active members. This would mean the fund will be treated as a non-complying fund. To overcome this difficulty, it would be necessary for Janet to also contribute to the fund at about the same time as Brad and the 50% active member test would be satisfied.

The issues with the residency of a superannuation fund is more likely to occur with SMSFs because a substantial proportion of members may travel overseas for a period and the central management and control may not be in Australia. In addition, it is more likely that a breach of the 50% active member test would occur due to the limit on the maximum number of members of an SMSF.

FUND ACCOUNTS ¶5-200 SMSF member accounts The role of structuring the fund accounts is a matter for an accountant, fund administrator or the client who may wish to use standard computer accounting software. When establishing fund accounts, the trust deed of the fund should be reviewed to ensure all aspects of the fund are identified from an accounting point of view as required by the trust deed. Examples of fund accounts would include accounts for members, investments, reserves, and income and expenses. A member’s account in an SMSF may include: • any contribution, including the co-contribution, low income superannuation tax offset, downsizer contribution, contributions made by the member, their spouse, employer or others on the member’s behalf. If a contribution is made in specie — by way of asset transfer — the member’s account should reflect the market value of the asset at the time the contribution is made to the fund although it should not be assumed the asset will relate specifically to the member • any rollovers or transfers from other superannuation funds or within the SMSF for the benefit of the member. A transfer within the fund would include transfers of contributions as a result of the member’s spouse contribution splitting • allocation of earnings by the trustee of the fund to the member’s account. How this is to be allocated and the timing of the allocation will depend on the provisions of the fund’s trust deed and other rules of the fund. This may require the income to be credited to a member’s account on the basis of the balance of the account at the commencement or end of the relevant year of income, and • any allocations by the trustee from the reserves of the fund. Reserves are special accounts established by the trustee of the fund for a specific purpose, eg a pension reserve is an account that the trustee has established to provide financial support and backing for any pension account which is for the benefit of a member or members of the fund. Amounts transferred from reserves of a fund may be included in concessional contributions and measured against the member’s concessional contributions cap in terms of reg 291-25.01 of the Income Tax Assessment Regulations 1997. In view of the ATO’s concerns over the use of reserves for avoiding the impact of the total superannuation balance and transfer balance caps reference should be made to the ATO’s SMSF Regulator’s Bulletin SMSFRB 2018/1. Items the trustee may decide to deduct from a member’s account, subject to the provisions of the fund’s trust deed include: • any lump sum withdrawal from the fund — otherwise known as a superannuation lump sum (s 307-65 of the ITAA97) • pension payments made to the member or their dependant otherwise known as a superannuation income stream (s 307-70 of the ITAA97) • a rollover or transfer of part or all of a member’s benefits to another complying superannuation fund or within the SMSF as a result of member contribution splitting • expenses of the fund — the trustee of the fund may incur a number of expenses for administering the fund, seeking actuarial and SMSF advice, receiving investment advice, audit fees, and so on. The trustee may charge these expenses to individual member accounts or against the income of the fund

depending on the circumstances • premiums for insurance policies on the life of the member or in the event of permanent or temporary disability • negative earnings where fund assets have performed poorly — this will only apply for funds running pooled investment accounts • a refund of non-concessional contributions made before 8 December 2007 which has been authorised by the ATO under a release authority (in view of the taxation of contributions in excess of the concessional, non-concessional contributions), and • an amount authorised under a release authority because a member has exceeded their transfer balance cap.

¶5-205 Event-based reporting From 1 July 2018, event-based reporting applies to SMSFs for the purposes of determining whether a member has exceeded their transfer balance cap. The timing of the reporting depends on whether members have a total superannuation balance of less than $1m or at least $1m. Under event-based reporting, SMSFs and in some cases, fund members, are required to report events which impact on a member’s transfer balance account or total superannuation balance by providing a transfer balance account report (TBAR) to the ATO. Reporting is only required if an event impacting a member’s transfer balance cap actually occurs — for example, when an SMSF member first starts to receive a pension from the fund. SMSFs have different reporting requirements for the 2017/18 financial year and the 2018/19 and future financial years. These reporting requirements differ from APRA funds and where a person is a member of an SMSF and APRA fund there may be a mismatch in what is reported and when it is required to be reported. This may result in an Excess Transfer Balance Cap Determination issuing in error due to the difference in reporting requirements, especially where a pension benefit is rolled over between an SMSF and an APRA fund and vice versa. An SMSF is required to report new pensions, partial commutations and pensions that ceased during the year by 28 days after the end of each quarter (September, December, March and June) or the due date of lodging the fund’s annual return. Quarterly reporting depends on whether fund has at least one member with a total superannuation balance of at least $1m at the time the fund first reported information for transfer balance cap purposes to the ATO. Commutations that are required to rectify a transfer balance account excess must be reported within 10 business days after the end of the month in which the commutation was made.

¶5-210 Market value reporting Trustees are required to keep such accounting records correctly that explain the transactions and financial position of the entity. Generally, the relevant accounting standard for superannuation funds is AASB 1056 Superannuation Entities. This accounting standard requires superannuation entities to bring to account all assets at their market value at reporting date. However, there is no requirement for an SMSF to meet the requirements of AASB 1056 unless it is regarded as a reporting entity. Where the SMSF is not a reporting entity, the accountant, trustee and auditor may end up falling back on the terms of the trust deed to determine how accounts for the fund are to be maintained. Section 35B(1) of SISA and reg 8.02B of SISR require the accounts and records of an SMSF to be at market value for ATO reporting purposes and in accordance with the ATO’s valuation guidelines for SMSFs. AUASB Guidance Statement GS009 Financial and Compliance Audits of SMSFs issued by the Australian Auditing Standards Board and the ATO’s valuation guidelines for SMSFs are relevant for the purposes of market value reporting.

¶5-220 Pooled or separated investment accounts In relation to member accounts, the trustee of the fund, along with the SMSF’s adviser and probably financial planner, may decide to run separate investment accounts for particular members or whether the fund investments are pooled with the allocation of earnings on behalf of members made at year-end or more frequently depending on the terms of the fund’s trust deed. The underlying framework for both types of account is generally authorised in the trust deed and governing rules of the fund. However, for separate investment accounts SISA provides two methods for providing this style of investment account in the fund. This can differ from the calculation of the fund’s exempt current pension income (ECPI) which determines the taxable and exempt income of the fund based on the proportion of the fund or investments allocated to accumulation and retirement phases. (1) Member choice SISA enables the trustee to offer members of the fund a choice of investment strategies. Under SISA s 52B(4) and SISR reg 4.02, this can be a lengthy process involving the trustee establishing more than one broad investment strategy for members. The trustee is also required to notify members of such other information that “the trustee reasonably believes a person would reasonably need for the purpose of understanding the effect of, and any risk involved in, each of those strategies”. Once all members are notified of their field of choices, each member must then choose and notify the trustee of their choice. For example, SISR gives the following example as indicative of member choice: “A strategy could allow the beneficiary, or class of beneficiaries, a choice of exposure to certain classes of assets. The beneficiary may choose 60% in fixed interest investments and 40% in shares”. Member choice of investment strategies is better suited to superannuation funds with many members. For most SMSFs the amount of administration generally makes this option not viable. (2) Trustee directed investment strategy The trustee may be given power under the rules of the fund to formulate separate investment strategies for each member or a class of members in the fund. In this situation the trustee has control and can override an investment strategy proposed by the member. Members of the fund may have input into which assets are to be included in the member’s investment strategy. Generally, if a fund is running separate investment accounts it may be better to adopt a trustee directed investment strategy. In doing this it is crucial the trustee ensures completion of compliance paperwork evidencing the use of the strategy. The use by the trustee of pooled or separate investment accounts for the fund is an issue that needs to be discussed soon after the establishment of the fund. In any case, the trustee should finalise the issue prior to any investments being made by the fund.

¶5-225 Annual returns SMSF trustees are required to lodge an annual return in respect of its operations each year. The annual return reporting requirements for SMSFs (ie a fund that was an SMSF at any time during the year of income) are set out in SISA s 35D. The lodgment date for an SMSF annual return is usually the date by which the fund is required to lodge its tax return for the year. The lodgment date is generally 31 October following the end of the income year for most funds, subject to some exceptions. From 1 October 2019, SMSFs with outstanding annual return lodgments are at risk of not receiving rollover benefits or employer super guarantee (SG) contribution payments for its members. The ATO has said that if an SMSF is more than two weeks overdue on an annual return lodgment due date, and has not requested a lodgment deferral, the status of the SMSF on Super Fund Lookup will be changed to “Regulation details removed”. This status means APRA funds will not roll over any member benefits to the SMSF and employers will not make any SG contribution payments for members of the SMSF. The ATO has asked SMSF trustees that do not expect to meet the due date to contact the ATO ahead of time to secure a lodgment deferral.

The SMSF annual return must be in the “approved form” and contain such information as the form requires in respect of the year of income. A trustee who contravenes s 35D commits an offence punishable by a penalty of 50 penalty units (fault liability) or 25 penalty units (strict liability).

THE TRUST DEED, SISA AND INVESTMENTS ¶5-300 Regulation of SMSFs Under SISA, all superannuation funds are required to satisfy the operating standards in s 31. These standards cover a range of issues in the operation of the fund including who may contribute to the fund, payment of benefits, accounts and investments. A trustee of a fund that breaches one or more of these standards may be subject to a number of directions, undertakings and penalties under SISA. There are a number of important provisions in SISA that relate to investments and are required to be understood by a financial planner advising a trustee on an investment of an SMSF. These include: • the trust deed • the sole purpose test • in-house assets test • the trustee acquiring an asset from a related party • borrowing by a trustee • lending to a member • investments to be on an arm’s length basis, and • no charge over the fund’s assets. Tax avoidance schemes targeting SMSFs The ATO has developed the Super Scheme Smart project warning trustees and retirees about illegal tax avoidance schemes targeting Australians planning for their retirement. These schemes encourage individuals to channel money inappropriately through their SMSFs. The ATO says these schemes have some common features, including that they: • are artificially contrived with complex structures usually connecting with an existing or newly created SMSF • involve a significant amount of paper shuffling • are designed to give the taxpayer minimal or zero tax, or even a tax refund • aim to give a present-day tax benefit by adopting the arrangement • invariably sound “too good to be true”, and as such they generally are. The penalties are substantial for those involved in deliberate tax avoidance schemes. The ATO says the penalties aren’t just financial, an individual may well lose their right to be a trustee of their own superannuation fund, or in some cases they could go to jail. Promoters of these schemes are also on the ATO’s watch list.

¶5-310 The SMSF trust deed

The trust deed is the first aspect of a compliance review of any investment made or about to be made by the trustee of the fund. In particular, the rules of the fund will provide the trustee with certain investment powers, including the power to invest in specific types of investments. As discussed previously, from a SISA perspective, s 55(1) of SISA requires the trustee and anyone else not to breach the trustee covenants in s 52B of SISA. These covenants oblige the trustees and anyone else to act in the interest of fund members in accordance with their fiduciary duties. Failure to comply with the relevant covenant does not render a transaction invalid but potentially leaves the trustee, their adviser or anyone involved in a breach exposed to a potential action under s 55(3) for any loss that has occurred as a consequence of the breach. For example, if the trustee decided to pay a member more than their entitlement in the fund or mixed fund investments with their personal investments, then the trustee would be in breach of a covenant and also an operating standard in the SISA. The decision of Hansen J in Dunstone v Irving 00 ESL 22; [2000] VSC 488 is interesting from the point of view that it involved an action under s 55 of SISA where a trustee was held to be personally liable for their actions. Apart from investments that the trustee can make, an area often found in the trust deed is the requirement for the trustee to make valuations in respect of fund investments at regular intervals. The valuation criteria may be found under the “investments”, “member accounts” or the “trustee accounts” clauses. The SISA requires that the valuation of a fund’s assets when preparing accounts and statements for purposes of s 35B(1) be made at market value in accordance with the valuation guidelines published by the ATO.

¶5-320 The sole purpose test The purpose for which a superannuation fund is established and maintained is pivotal to it maintaining compliance under SISA and retaining tax concessions (refer to SMSF Ruling SMSFR 2008/2). This is referred to as the “sole purpose test” and requires a regulated superannuation fund be maintained solely for the provision of the following benefits for members of the fund: • retirement benefits • benefits for each member of the fund on reaching age 65, and • the provision of benefits for the legal personal representative or the member’s dependants in the event of the member’s death. The definition of dependant not only includes a financial dependant but also the spouse and children of the deceased member even though they may not be a financial dependant. It also includes a person with whom the member has an interdependency relationship. The section also goes one step further and lets the trustee maintain the fund for other purposes on the condition that at least one of the three core purposes above is satisfied. The other purposes are: • the provision of benefits to a member of a fund after termination of employment with an employer or associate who had contributed to the fund. The preservation rules limit when these benefits may be paid to the member, and • the provision of benefits to a member where the member terminates employment as a consequence of ill-health. Where the fund is not maintained solely for the required purposes, the trustees are exposing themselves to possible disqualification, penalties and treatment of the fund as a non-complying fund. It is more likely that an SMSF and other smaller superannuation funds may breach the sole purpose test as there is a greater likelihood that trustees are able to pay benefits or access the assets of the fund in breach of SISA. There are a number of court and tribunal decisions on the interpretation of the sole purpose test. In Aussiegolfa Pty Ltd (Trustee) v FC of T 2018 ATC ¶20-664, the trustee of the SMSF invested directly in a residential property through a real estate trust. The property was leased to the daughter of the trustee (who was not a member of the SMSF). The Full Federal Court held that the leasing of the property to the trustee’s daughter did not breach the sole purpose test.

Following this decision, the ATO released a decision impact statement which stated that it does not consider the case to be an authority for the proposition that a superannuation fund trustee can never contravene the sole purpose test when leasing an asset to a related party simply because market value rent is received. The ATO noted that in the circumstances of the case the property had been previously leased to two unrelated tenants for two years prior and that the daughter had paid the same amount of rent as that paid by the previous tenants. There was no suggestion that the leasing of the property to the daughter had influenced the fund’s investment policy. Because of uncertainty concerning the ATO’s decision impact statement, DomaCom Australia Ltd, which was involved in promoting products similar to the Aussiegolfa case, has updated their product requirements to include a declaration concerning the application of the sole purpose test where a breach of s 62 may have occurred. As a result the ATO has undertaken not to conduct compliance activities into these arrangements where a breach of the sole purpose test may have taken place if the trustee has made the relevant declaration. The ATO has extended this offering to other trustees who have entered into similar arrangements. In the Swiss chalet case, AAT Case 43/95 95 ATC 374, the Administrative Appeals Tribunal held that the trustees of the fund had failed to maintain the fund solely to provide benefits to members on the occurrence of the events stipulated in the legislation. Broadly, the trustee of the fund had invested in three investments: (1) shares in a private company that had as its only investment shares in a golf club. The golf club shares allowed the trustee to nominate playing members for the club. The trustee nominated himself and a friend as playing members. However, both the trustee and the other nominated person paid yearly fees to play on the course (2) an investment in a family trust that held a Swiss chalet as its only investment. The chalet was used by the trustee, his family and friends and no record of rent could be found. The tribunal noted the poor documentation surrounding the overall investment. (3) a house in Sorrento, Victoria. The house was used by the trustee for personal uses as well as by the trustee’s business for planning days. Rent had been paid for use of the house. As a result the fund was held to be a non-complying superannuation fund under the legislation applying at the time. In the case of DFC of T (Superannuation) v Fitzgeralds and Anor 2007 ATC 5105; [2007] FCA 1602, the ATO’s Deputy Commissioner of Superannuation successfully imposed civil penalties on fund trustees who failed to meet the sole purpose test and also breached s 65 relating to prohibition of loans to members and relatives of members. Other court and tribunal cases where the sole purpose test was considered to be breached include Olesen v MacLeod 11 ESL 11; [2011] FCA 229 and Olesen v Eddy 11 ESL 02; [2011] FCA 13, Olesen v Parker & Parker 11 ESL 21; [2011] FCA 1096, AAT Case [2011] AATA 403, Shail Superannuation Fund v FC of T 2011 ATC ¶10-228; [2011] AATA 940, Triway Super v FC of T 11 ESL 12; [2011] AATA 302 and Trustee for the R Ali Superannuation Fund v FC of T 2012 ATC ¶10-231. Some of these decisions included the imposition of penalties by the court for withdrawal of amounts by the trustee of the relevant fund in breach of the sole purpose test and preservation standards. In addition, those funds were treated as non-complying funds. In ATO ID 2015/10, an SMSF was considered to have contravened the sole purpose test by purchasing a life insurance policy over the life of a member of the SMSF where it was a condition and consequence of a buy-sell agreement the member has entered into with his brother as co-owners of their business.

¶5-330 The in-house assets test There are a number of restrictions on what a superannuation fund may invest in. As a general rule, these restrictions apply to investments associated with parties related to the fund, such as a member, a trustee, their relatives or entities they “control” either individually or as a group. Some of the rules for investments

are less restrictive in the case of funds with less than five members, such as SMSFs and small APRA funds (SAFs). The in-house assets test ensures that a superannuation fund does not invest more than a modest portion of the SMSF back with those related to the fund. This is designed to reduce the investment risk so that superannuation savings are preserved for retirement purposes and members’ benefits in the fund are protected. The in-house assets rule was designed to limit a strategy where employers made large contributions into a fund and then lent the money back to a party related to the fund or used it to invest back into their business. The in-house assets test provides that the trustee of a superannuation fund must hold no more than 5% of the market value of its total assets as in-house assets. However, there are a number of exemptions and transitional rules which exclude certain related party investments from being included in the measurement of a fund’s in-house assets. Due to the complexity of the in-house asset rules, great care needs to be taken when determining whether a particular investment, loan or lease falls within the definition of an in-house asset. It is for this reason that it may be worthwhile to obtain an opinion from someone who specialises in the investments of SMSFs. What is an in-house asset? The definition of an in-house asset is found in SISA s 71(1) and includes a loan or investment made by the trustee of a superannuation fund in a related party of the fund, an investment in a related trust of the fund or an asset of the fund subject to a lease or lease arrangement between the trustee of the fund and a related party. Some of the important terms used in the definition are discussed below. Who is a related party of the fund? A related party is defined in SISA s 10(1) and Pt 8 to include a member, a trustee and an employer who contributes into the fund under an arrangement with the trustee of the fund — known as the employersponsor. Related party also includes people and entities that are in some way connected to the fund and its members or employer-sponsor: • any relative of the member including grandparents, lineal descendants and their spouses • a partnership where the member or employer-sponsor are partners. This includes the partners themselves, their spouses and their children • any company or trust controlled by a member of the fund or employer-sponsor including a company where the member and any associated party of the member holds a controlling interest in the company or trust either individually or as a group. What is a related trust of the fund? The definition of a related trust is found in SISA s 10(1) and means a trust where a member or employersponsor and their associates hold: (a) more than 50% of the rights to income or capital of the trust (b) holds a right to appoint or remove the trustee(s) of the trust, or (c) where the trustee of the trust is accustomed or required to act according to the instructions, directions or wishes of the member or employer-sponsor. Where the trustee of the fund invests in a unit trust and does not have effective control or power over the appointment of a trustee, the investment is not in a related trust under s 70E of SISA and thus not an inhouse asset. For example, where the trustee invests in a managed fund or property syndicate that is open to the broader public, such investments would not be in-house assets. This type of trust usually meets the definition of a “widely held trust”. A trust is a widely held trust if: • it is a unit trust in which entities have fixed entitlements to all of the income and capital of the trust, and

• no fewer than 20 entities between them have fixed entitlements to 75% or more of the income of the trust, or fixed entitlements to 75% or more of the capital of the trust. Another example is published by the ATO in ATO ID 2014/23 where a loan was made by an SMSF to a unit trust where related parties owned less than 10% of the units in the trust. A trust which holds investments for purposes of a limited recourse borrowing arrangement under s 67A of SISA will be an in-house asset of the fund if the investments of the trust are in-house assets. What is a lease or lease arrangement with a member? The definition of an in-house asset extends to a lease or lease arrangement with a member or employersponsor and is discussed by the ATO in greater detail in SMSF Ruling SMSFR 2009/4. Importantly, a lease arrangement does not necessarily mean a formal lease entered into by the trustee of the fund. The term “lease arrangement” is defined in SISA s 10(1) to mean “any agreement, arrangement or understanding in the nature of a lease (other than a lease) between the trustee of a superannuation fund and another person, under which the other person is to use, or control the use of, property owned by the fund”. If a lease is caught, the market value of the underlying property is included in the value of the fund’s in-house assets and not the value of the lease. As an example, “if a superannuation fund owns a beach house and leases it to a member for two months of the year, the full market value of the beach house is included in the value of the fund’s in-house assets — despite the fact that the member may pay full commercial rent for the period of occupation”. Trustees of superannuation funds with investments in holiday homes, ski lodges, residential property and other property investments must be extremely careful not to let members stay in the property, even if it is only for one night. Since the in-house assets test is a day-by-day test — any stay by the member would require the trustee to include the market value of the property as an in-house asset of the fund. If the market value exceeds the 5% rule, then the trustee is in breach of the in-house assets test. Additionally, the definition of lease extends to an arrangement that is not a lease but where a right to use exists. Therefore, the in-house assets test extends to the use of a fund asset by a member of the fund, including antiques, classic cars, golf club memberships and artwork. Since 1 July 2011, changes to the sole purpose test have placed tighter legislative standards for new investments in collectables and personal use assets. In addition, all holdings of collectables and personal use assets by SMSFs owned by the fund as at 1 July 2011 were required to comply with the new rule by 1 July 2016. Funds that are unable to meet the transitional rules were required to dispose of the artwork or collectable by 1 July 2016. The regulations require the artwork or collectable to be stored appropriately, valued by an approved valuer at the time of disposal to a related party, insured and cannot be leased to a related party. Anti-avoidance rules Generally, the anti-avoidance rules in SISA Pt 8 catch most attempts by trustees to circumvent the inhouse assets rules. In particular, s 71(2) provides that where an arrangement has been entered into and a person is aware that, as a result of the arrangement, a loan, investment or lease to a related party or a related trust is not caught by the in-house assets test then the asset is taken to be an in-house asset. Apart from the anti-avoidance rules, s 71(4) empowers the ATO to deem, by written notice, any investment, loan or lease undertaken by the trustee of the fund to be an investment, loan or lease arrangement with a related party or an investment in a related trust. In the case of Aussiegolfa Pty Ltd (Trustee) v FC of T 2018 ATC ¶20-664, the court deemed an investment in a sub-trust which owned a home unit rented to a relative of a member of the SMSF to be an in-house asset. Exceptions to the in-house assets test SISA s 71(1) provides a number of important exceptions to the definition of an “in-house asset” including: • a life insurance policy (other than a policy acquired from a member of the fund or a relative of a member) • a lease involving business real property. Where the trustee of the fund with less than five members enters into a lease arrangement of business real property with a related party the lease is not an in-

house asset. Business real property is property that is used wholly and exclusively for business purposes and would include a farm operated as a primary production business but not a hobby farm (¶5-350) • a managed fund — an investment in a widely held trust such as a commercial managed fund • a term deposit or other similar style of investment with a bank, credit union or building society • property held in partnership with a related party is excluded from the in-house assets test unless it is subject to a lease arrangement with a related party, and • an asset of the fund that is held in trust and is subject to a direct or intermediary limited recourse borrowing arrangement under s 67A, 67B or 67(4A) of the SISA. A further special purpose exemption has applied since late 2000 under SISR reg 13.22C allowing the trustee of the fund to invest in a related fixed trust (or company) provided the following conditions are met: • the unit trust does not borrow • the trustee does not invest in another entity • there is no charge over an asset of the unit trust • the unit trust does not invest in or lend money to individuals or other entities — normal deposits with banks, credit unions and building societies are excepted • the unit trust has not acquired an asset from a related party of the fund after 11 August 1999 other than business real property • the unit trust does not acquire an asset, other than business real property, that has been owned by a related party of the fund in the previous three years • the unit trust does not directly or indirectly lease assets to related parties other than business real property • the unit trust does not conduct a business, and • the unit trust conducts all transactions on an arm’s length basis. In addition to the above exceptions, certain investments, leases and loans that were held by the fund as at 11 August 1999 are also excluded from the value of the fund’s in-house assets, providing they were not defined as in-house assets under the previous definition (s 71A to s 71E of the SISA). These include: • shares held in a related company • units in a related unit trust, and • leases that were in place pre-11 August 1999 and have continued uninterrupted (s 71B and 71C). Further transitional rules applied from 11 August 1999 until 30 June 2009 to allow the fund to acquire additional units in a pre-11 August 1999 unit trust or shares in a pre-11 August 1999 company. One of two rules may apply in these circumstances. The first rule is that the fund could have reinvested any distributions or dividends received from the relevant unit trust or company prior to 30 June 2009, and the value of those units is not included in the fund’s in-house asset. A second rule may apply to permit the fund to purchase additional units or shares prior to 30 June 2009 up to the value of any loan the unit trust or company had outstanding as at 11 August 1999. The second rule applies only where the trustee made an election as at 23 December 2000 and is mutually exclusive from the operation of the first rule (s 71D and 71E). Another transitional rule allowed a fund to make additional payments on partly paid units in a unit trust or

shares in a company until 30 June 2009. The additional payment made up until 30 June 2009 on the units or shares is not included in the value of the fund’s in-house assets (s 71A). The transitional in-house asset rules are relatively complex, and from a financial planning point of view the value of a fund’s in-house assets should be ascertained by consulting the fund’s accountant or tax adviser. This will allow the financial planner to work out whether the fund is able to purchase or enter into additional in-house assets where the fund’s in-house assets are within the 5% limit or make a plan for the disposal of certain in-house assets if the 5% limit has been exceeded. In-house asset strategies for pre-1999 unit trusts and companies Since 1 July 2009, it has been necessary to consider the impact of the cessation of the transitional rules on pre-1999 unit trusts and companies. This requires understanding the transitional rules clearly to determine which investments of the fund do not form part of the fund’s in-house assets or, if they do, whether the 5% limit has been met. The main issue in relation to the pre-1999 unit trust or company is the ability of the relevant entity to maintain cash flow and pay expenses. In cases where the expenses of the pre-1999 unit trust or company are greater than its income, it is necessary to implement strategies to ensure it remains liquid. It may be a simple matter of reducing the expenses of the unit trust or company so that it breaks even or is placed in a position with a positive cash flow. This could be done by extending the terms of any loan that is outstanding or by changing from a principal and interest loan to an interest-only loan. In other cases, it may be necessary for the unit trust to issue units, or the company to issue shares, to parties other than the superannuation fund. Another method could be for the pre-1999 unit trust or company to borrow money to pay expenses until it attains a profitable position.

¶5-350 Acquisition of assets A member of the fund, or another person such as an employer, may ask the trustee to accept a contribution in specie on his or her behalf. If the trustee accepts the contribution as a transfer in specie, then an asset or group of assets will be transferred into the fund on behalf of the relevant member or members. The market value of the assets at the time of the contribution will be the relevant amount contributed to the fund. The concessional, and particularly non-concessional, superannuation contributions cap places a limit on the value of the asset that can be contributed to the fund in cash or as an in specie transfer without a penalty being incurred. If the value of the asset made as a single contribution exceeds the nonconcessional contributions cap for the person, the trustee is required to refund the excess. This can be difficult with assets that are not easily split, such as real estate, and exceed the member’s nonconcessional contributions cap. In relation to the use of an unallocated contributions account in the fund and making an in specie transfer of assets, the ATO’s opinion in Taxation Determination TD 2013/22 should be considered. What is a contribution to the fund? What constitutes a contribution being made to the fund has been discussed by the ATO in Taxation Ruling TR 2010/1. As a general rule a superannuation contribution is made to a fund when there is an increase in its capital value, for example, and the contribution is received in money or its equivalent. Receipt of money by the trustee as a cheque or promissory note is a contribution when it has been obtained by the fund trustee. The trustee is expected to seek payment of the cheque or promissory note promptly and usually within a few business days of receipt in line with normal commercial practice. If the trustee delays cashing the cheque or promissory note beyond that time, the ATO will treat the contribution as having been made at the time the cheque or promissory note is cashed. This may create some issues where the receipt and cashing of the cheque or promissory note occurs in two different financial years. Where an in specie transfer of assets is made as a contribution to the superannuation fund, receipt depends on a number of factors including the type of transaction and the particular asset involved. If the contribution involves an in specie transfer of real estate, the contribution is considered to have been made

when the trustee of the fund receives the necessary transfer forms relating to the property from the transferor (vendor or seller) which is usually at the time of settlement of the property. If shares in a listed company are transferred to the fund, the contribution is recognised as made when the shares are transferred via the Clearing House Electronic Subregister System (CHESS). However, if the transfer of shares is made as an off-market transaction, the fund is considered to receive the contribution when a properly completed off-market share transfer has been obtained from the contributor. In cases where there is no formal registration process that evidences the transfer of the ownership of an asset, the ATO accepts ownership of the property passes when the fund obtains possession. However, for the purposes of making a contribution, ownership may also pass on the execution of an agreement for the transfer of the asset. A contribution may be recognised as having been made to the fund in a number of other circumstances, for example, debt forgiveness and in relation to certain guarantees. The ATO considers a contribution to have been made where a lender forgives a debt relating to a limited recourse borrowing arrangement entered into by the fund. Also, in relation to a limited recourse borrowing arrangement, if a guarantor provides a personal guarantee and they forgo the right to any payment made in that respect, the value of the guarantee is considered to be a contribution. A contribution is considered to have been made to a superannuation fund at the time an expense is paid on behalf of the fund by a third party, where there is no expectation of reimbursement. Contributions are also considered to have been made: • when a distribution is made to a superannuation fund from a discretionary trust • by a transfer of a benefit from a foreign superannuation fund, and • on the rollover of a superannuation benefit to the fund. Acquisition of assets from a related party If assets are transferred to the fund by a related party, the trustee must ensure the assets abide by SISA s 66 that prevents, except in limited circumstances, the acquisition by the trustee of an asset from a related party (refer to SMSF Ruling SMSFR 2010/1 relating to the acquisition of assets from related parties). The penalty for a breach of s 66 is up to one year imprisonment. There are some important exceptions to s 66 allowing the trustee to acquire from a member or employersponsor the following assets at market value, either by way of a contribution or purchase. • Listed securities. A listed security is defined in s 66(5) as being any share, debenture, option or other instrument listed for quotation on the Australian Stock Exchange (ASX) or other Australian satellite exchanges plus major overseas exchanges such as the New York and London stock exchange. • Business real property. Business real property is property that is used wholly and exclusively in one or more businesses. This would include commercial property but residential property does not generally meet the definition of business real property (refer to SMSF Ruling SMSFR 2009/1). • Rural farming property. A farm is classified as business real property even though there may be a homestead or areas set aside on the farm for domestic purposes. The two limitations for the transfer by a member or related party of a farm are: – that any area used for domestic purposes, for example a homestead area, must be no more than two hectares in total, and – that the dominant purpose for holding the farm is for primary production, not for domestic or private purposes or as a hobby farm. • A managed fund. An investment in a widely held trust such as a commercially managed fund is allowed under the rules. • A term deposit or other similar style of investment with a bank, credit union or building society.

• An in-house asset, provided it is acquired at market value and does not result in the level of in-house assets exceeding the level permitted, currently 5% of the market value of the fund’s assets. The transfer of investments between SMSFs involves the acquisition of assets by the acquiring fund from a related party, the transferring superannuation fund. Where a fund investment is not permitted to be transferred under s 66 because it does not come within the exceptions to the general rule, then the transfer cannot take place. Any transfer that does take place is a disposal and acquisition for capital gains tax purposes. For example, if a member had listed share investments valued at $100,000 they could be transferred to the fund in specie in one transaction as a contribution. The only considerations are the impact of capital gains tax on the person making the transfer and potential stamp duty implications, if any, for the fund. In a family law settlement one party may wish to transfer assets to another SMSF. For this purpose s 66 allows the transfer of the assets to the other SMSF where they form part of the settlement. This is notwithstanding that the transfer of particular assets may be technically in breach of the section as the transfer is taking place between SMSFs which may be considered related parties due to one or more trustees being common to both funds. In addition to the transfer of investments that constitute part of a family law settlement, a member may also transfer other investments that support their account balance to another superannuation fund without being in breach of s 66. The investments subject to the transfer will not be subject to capital gains tax until they are disposed of by the fund to which the investments are transferred. There are strong anti-avoidance provisions that apply to any person who enters into an arrangement with the purpose of avoiding the operation of s 66. A case relating to the application of the anti-avoidance provisions is Lock v FC of T 03 ESL 06; [2003] FCA 309, where the trustee of a fund was held to be in breach of s 66(3) by attempting to use an interposed unit trust to transfer residential property into the fund. Also, ATO ID 2011/84 discusses the application of anti-avoidance provisions of s 66 in relation to the acquisition of units in a unit trust. Contributions rules and in specie contributions Since 1 July 2007, amendments to the ITAA97 have placed a limit on the amount of superannuation contributions that is eligible for concessional tax treatment. For the 2020/21 financial year, the maximum amount of non-concessional contributions that are not subject to a penalty tax is $100,000 pa. However, for anyone aged under 65, it is possible to make non-concessional contributions of up to $300,000 over a set three-year period without penalty. This is referred to as the bring forward rule and applies from the first year in which a non-concessional contribution of more than $100,000 is made to the fund. If a person has a total superannuation balance of less than $1.4m on 30 June in the previous year, then they can bring forward the next two financial years’ non-concessional contribution. If their total superannuation balance is between $1.4m and $1.5m, they can bring forward the next financial year’s non-concessional contribution, and if their balance is between $1.5m and $1.6m, they are unable to bring forward any amount. If a person has a total superannuation balance of more than $1.6m, it is not possible to make any non-concessional contributions without incurring an interest rate and tax penalty (¶4-250). The effect of the legislation is significant on superannuation fund members, particularly members of SMSFs, who may need to consider a longer time horizon to accumulate the amount they desire for their retirement. In some cases this may involve establishing structures to facilitate the transfer of the investment to the fund. A number of strategies may need to be considered by anyone proposing to make an in specie transfer of investments to their SMSF as non-concessional contributions. This would occur mainly in the case of large assets such as business real property transferred from a related party. Other investments such as shares can be divided into smaller parcels to satisfy the concessional and non-concessional caps. It should be noted that, with respect to contributions made prior to 1 July 2017, where shares are transferred to the fund in specie each parcel of shares constitutes a separate contribution even if the transfers of the parcels take place during the same day (ATO ID 2012/79 (withdrawn)). Therefore, up until 30 June 2017, any single parcel of shares that exceeds the non-concessional contributions cap must have the excess refunded to the contributor, not the combined value of shares made during the day. From 1 July 2017, there is no restriction on the amount that can be contributed to the fund; however, any

excess will be subject to the excess concessional or excess non-concessional contributions tax. Some of the strategies that could be used to make non-concessional contributions to the fund in specie are: • the SMSF purchases some or part of the investment if it has the cash • ownership of part of the investment is transferred to the SMSF and the ownership of the remainder of the property being held by the member or other party • a company or unit trust could be established and shares or units could be issued in exchange for business real property owned by a member. The member could then transfer the shares or units received for transfer of the property over time to the superannuation fund. However, the trustees of the SMSF would need to ensure that the in-house asset rules and other SISA investment rules were satisfied. There are also potential capital gains tax and stamp duty issues to be considered. Contribution rules and SuperStream changes The SuperStream reforms are designed to assist employers in simplifying making contributions to superannuation funds. Employers are generally required to meet the SuperStream requirements when making superannuation contributions electronically on behalf of employees. If the employer is a “related party” as defined in s 10(1) and Pt 8 of the SISA, there is no requirement for the employer or the SMSF to comply with the contribution requirements under the SuperStream changes. For this reason, most SMSFs do not use SuperStream, but it was proposed to require SMSFs to comply with the SuperStream arrangements from November 2019. However, this has been deferred until 2021 as announced in the 2019 Federal Budget and confirmed by the government and ATO. To enable contributions to be made to the SMSF, an employer must be notified of the SMSF’s ABN, bank account details and electronic service address. In most cases the employer will have the ABN and bank account details; however, they may not have the fund’s electronic service address. Electronic service addresses can be obtained from providers who are listed on the ATO website. There may be a cost associated with obtaining some electronic service addresses.

¶5-360 Trustee allowed to borrow in limited circumstances The trustees of an SMSF must not borrow or maintain an existing borrowing of money, except in limited circumstances. A borrowing is allowed where the trustee needs to cover settlement on the purchase of an asset which was not anticipated at the time of purchase or where a benefit payment must be made. Any borrowing must be short term, ie less than seven days for securities transactions and 90 days for benefit payments. In addition, the borrowing cannot exceed 10% of the value of the fund’s assets. In the case of SMSFs, borrowing has very limited application in view of the amount that can be borrowed and the time in which the borrowing must be repaid. The ATO has issued SMSF Ruling SMSFR 2009/2, which discusses the meaning of “borrowing” or “maintain an existing borrowing of money” for purposes of the SISA. Since September 2007, a superannuation fund has been permitted to borrow for purposes of entering into a limited recourse borrowing arrangement. The legislation was amended from 7 July 2010 and became more restrictive than the earlier rules. The information on the earlier legislation remains relevant as the pre-7 July 2010 legislation continues to have application to any arrangement that was entered into prior to that time. However, any variation to the arrangement may require it to meet the post-7 July 2010 rules. The legislation that applied from 23 September 2007 until 6 July 2010 referred to the borrowing arrangement as an instalment warrant (s 67(4A) of the SISA). Any arrangement to borrow by the fund must have been made on the following terms: • The borrowing must be used to acquire an asset which may include, but is not limited to, equities, property or managed investments and may include exotic investments such as artworks. The artworks and collectables may be held subject to the operation of s 62A relating to their acquisition, storage and maintenance.

• The investment must be held on trust (generally accepted to be as bare trustee and may be referred to as a holding trust or custodian trustee) so that the superannuation fund has the beneficial interest and the right to acquire the legal ownership of the investment, or any replacement, by the payment of instalments. • The recourse of the lender against the superannuation fund trustee is limited in the event of default on the borrowing and related fees, or the exercise of rights by the fund trustee. The limit is to the rights over the asset and the lender is not permitted to recover money from the fund’s other assets. • Any asset or its replacement must be one which the superannuation fund trustee is permitted to acquire and hold directly. That is, the investment is subject to the SISA rules for fund investments. The in-house asset rules were also amended to exclude an investment held on trust from being an inhouse asset unless the investment would ordinarily be an in-house asset if held directly by the fund. In some situations when a deposit has been placed for the purchase of a property or it is to be sold or disposed of, the technical requirements of s 67(4A) or s 67A may not be satisfied. One of the reasons may be that the loan did not become available until settlement of the purchase or, on disposal of the asset, the loan may have been paid out prior to transfer. Legislative Instrument Self Managed Superannuation Funds (Limited Recourse Borrowing Arrangements — In-house Asset Exclusion) Determination 2014 caters for these situations and treats the fund as meeting the requirements of s 67(4A) or s 67A. The Legislative Instrument applies retrospectively to all limited recourse borrowing arrangements from 24 September 2007. Amendments were also made by the Superannuation Industry (Supervision) In-house Asset Determination — Intermediary Limited Recourse Borrowing Arrangement Determination 2020 to exclude limited recourse borrowing arrangements where the borrowing was undertaken by the underlying trust rather than the superannuation fund. This Determination applies retrospectively to arrangements entered into from 24 September 2007. The practicality of the “instalment warrant” arrangement is that the fund requires an appropriate investment, a trust structure and a source of limited recourse finance. There are no restrictions on who provides the finance for the superannuation fund. The financier can include any financial institution, a related entity or a member of the fund. However, where the loan is obtained from non-arm’s length sources it is recommended that the ATO’s safe-harbour guidelines as published in Practical Compliance Guideline PCG 2016/5 are followed. Failing to meet the safe-harbour guidelines may result in the income earned by the fund being treated as non-arm’s length income and taxed at 45%. As all the investment rules for purposes of the SISA apply in relation to the borrowing arrangement, the investment must be consistent with the investment strategy of the fund. In addition, the investment must not be prohibited from being acquired directly by the superannuation fund. As an example, a residential property acquired from an arm’s length third party may be an acceptable investment for purposes of the borrowing. However, a residential property acquired from a related party of the fund would not be acceptable as the transaction would be in breach of s 66 of the SISA. The following chart illustrates the relationship between the parties to the borrowing arrangement for purposes of s 67A and previously s 67(4A) of the SISA:

Example Example of the use of the borrowing arrangements under s 67A and previously s 67(4A) of the SISA Sue and Scott are members of an SMSF. The SMSF currently has total assets of $450,000 invested across a range of fixed interest, cash, equity and indirect property. They have identified a commercial property investment that they would like the fund to acquire from an unrelated third party for about $400,000. The plan is to lease the property to an arm’s length third party after acquisition. Subject to the SMSF’s investment strategy, it could ordinarily acquire the investment. If the SMSF was to sell its current assets to acquire the property, it would have a significant exposure to direct property. If the SMSF was to use a limited recourse borrowing arrangement, it would be possible for it to commit less of its assets to the property investment. This would allow the SMSF to maintain some diversification while at the same time increase the SMSF’s exposure to property by use of the limited recourse borrowing arrangement. If the SMSF was to invest $200,000 to purchase the commercial property via the limited recourse borrowing arrangement and obtain an appropriate level of finance, the SMSF’s exposure to property would be controlled. Over time the SMSF would be required to make payments to reduce and eventually eliminate the outstanding loan. Once that has occurred, legal ownership of the property may be transferred to the SMSF.

Amendments to the borrowing rules A number of amendments were made to the borrowing arrangements from 7 July 2010. The amended legislation in s 67A and 67B is designed to clarify the provisions of s 67(4A). The legislation that applies to limited recourse borrowing arrangements from 7 July 2010: • defines the term “asset” so that it is limited to a single acquirable asset • limits the rights of any person against the super fund trustee that arise either directly or indirectly from default on the borrowing to those relating to the asset that is subject to the borrowing arrangement • restricts the replacement of the asset that is the subject of the borrowing arrangement to very limited circumstances as specified in the law • prevents super fund trustees from using the amount borrowed to improve any real property or any other asset which forms part of the borrowing arrangement • restricts any borrowing by the fund to a single asset, for example, a single title over real property or a collection of identical assets that have the same market value and are treated as a “whole” asset, eg a parcel of shares of the same type in a single company • prevents the asset that forms part of the borrowing arrangement from being subject to a charge other

than in relation to the borrowing made by the super fund trustee. The main impact of the change for SMSFs affects those arrangements involving real property or arrangements involving a basket of investments. For example, under the previous legislation for instalment warrants it was possible for the amount borrowed by the fund to be used to purchase property which may extend over a number of titles, for example, a business property. The amended legislation permits a single acquirable asset only to form part of one limited recourse borrowing arrangement. Therefore, as a general rule, each title must form part of a separate limited recourse borrowing arrangement. Another example would be the situation where the borrowing was used to purchase a block of land or a property to be redeveloped. While this may have been permissible under the previous rules in s 67(4A), s 67A and 67B do not permit the limited recourse borrowing arrangement to form part of a subdivision or redevelopment. The reason is that the original nature of the “single acquirable asset” has been changed by the subdivision or redevelopment. In May 2020 the ATO published SMSF Regulator’s Bulletin SMSFRB 2020/1 concerning SMSFs investing in property development, citing concerns over some arrangements which are considered in breach of the SISA. In the situation where a superannuation fund borrows to acquire shares that will be subject to limited recourse borrowing arrangements, each parcel of shares in a particular company will be subject to a separate limited recourse borrowing arrangement. In addition, the price paid for all the shares in the parcel must be identical. In view of the manner in which most shares are purchased by a broker, it is common that different prices may be paid for shares that comprise the parcel. This makes compliance with the amended legislation difficult in some cases. Some limited recourse borrowing arrangements have involved loans usually from private sources on an interest-free or discretionary interest rate as agreed between the superannuation fund and the lender. The ATO has issued ATO ID 2010/162 indicating that an interest-free loan is not a breach of s 109 of the SISA in situations where the superannuation fund is not disadvantaged by the transaction. However, Private Binding Rulings issued in 2015 as well as Taxation Determination TD 2016/16 determined that income earned on investments involving limited recourse borrowing arrangements which include interest-free loans may be treated as non-arm’s length income under s 295-550 of the ITAA97. The Commissioner has issued Practical Compliance Guideline PCG 2016/5 detailing interest rates, loanto-value ratios and other terms that constitute a safe-harbour for SMSF limited recourse borrowing purposes. Arrangements which fall within these guidelines will have any income that has been earned by the superannuation fund from limited recourse borrowing arrangements taxed as ordinary income rather than non-arm’s length income. If these requirements are unable to be met, the fund will have its income earned from the relevant limited recourse borrowing arrangement taxed as ordinary income, providing the safe-harbour arrangements were met by 31 January 2017. The ATO has information on its website which includes the factors to be taken into account when determining if the income earned by the fund is treated as non-arm’s length income. Interest rates for related party loans are reviewed annually by the ATO. The interest rates for the 2020/21 financial year are 5.10% for real property and 7.10% for listed shares. For the 2019/20 financial year, the interest rates were 5.94% for real property and 7.94% for listed shares. The Tax and Superannuation Laws Amendment (2015 Measures No 2) Act 2015 clarifies the CGT treatment of instalment warrants including limited recourse borrowing arrangements. This amendment permits a superannuation fund that enters into a borrowing arrangement for the purposes of s 67(4A) or s 67A and 67B to be deemed the owner of the underlying asset. These amendments are backdated to 24 September 2007 which coincides with the commencement of the limited recourse borrowing arrangements. See also ¶2-300. The ATO’s interpretation of what is meant by a “single acquirable asset” and a “repair”, “improvement” and “replacement” of an asset as those terms relate to limited recourse borrowing arrangements is published in SMSF Ruling SMSFR 2012/1. Limited recourse borrowing arrangements and the $1.6m transfer balance cap Any limited recourse borrowing contracts entered into from 1 July 2017 may result in a credit to a person’s

transfer balance cap. It does not apply to contracts already in place as at 1 July 2017, refinancing of a limited recourse borrowing in place at that time or contracts entered into prior to that time but settled on or after 1 July 2017. The credit to a member’s transfer balance account in relation to a limited recourse borrowing arrangement occurs if the superannuation fund makes a payment that has the effect of increasing the value of a superannuation interest from accumulation phase to retirement phase. A transfer balance credit does not arise if the payment in relation to the limited recourse borrowing arrangement is made from assets in the retirement phase. Therefore, it is necessary to identify the source of the relevant payment as coming from either accumulation or retirement phase of the fund. The credit applies only to funds which use the segregated method to determine their taxable and tax exempt income as it is possible to measure the shift in value from accumulation phase to retirement phase. Funds which use the proportional or unsegregated method to determine taxable income are not impacted by this legislation. Example Roger is the only member of an SMSF with a superannuation interest in accumulation phase valued at $1.6m. The SMSF enters into a contract on 1 August 2017 to acquire a property for $600,000 using $300,000 cash from the fund and $300,000 as a borrowing via a limited recourse borrowing arrangement. On 31 August 2017 Roger commences an account-based income stream using all of his $1.6m accumulation interest which is supported by the property. The repayments on the property are made from rental income and cash held by the fund. The monthly repayments are $1,250 pm. As the repayments are sourced from assets that support Roger’s retirement phase there is no increase in the value of his superannuation interest supporting his account-based pension. Therefore, there is no transfer balance credit arising from the repayments. However, as a comparison, assume that if Roger had $1.6m in accumulation phase and used $1.5m to commence an accountbased pension, with the remaining $100,000 left in accumulation phase. The amount in accumulation phase is used to make the repayments of $1,250 pm on the property which forms part of a limited recourse borrowing arrangement and the net value is allocated to retirement phase. In this situation the amount of the repayments would be credited to Roger’s transfer balance account.

Limited recourse borrowing arrangements and the $1.6m total superannuation balance Amendments were made to include a proportion of the outstanding balance of an LRBA loan that was entered into on or after 1 July 2018. The proportion of the outstanding balance is counted as a credit against a person’s total superannuation balance cap subject to certain conditions applying. Those conditions apply to include the outstanding balance of an LRBA as a credit to the cap for related party loans or any arm’s length loan where a member meets a condition of release with a cashing restriction of nil. Example Terry and Linda are members of an SMSF and commenced a limited recourse borrowing arrangement on 1 July 2019. The SMSF borrowed $600,000 on an interest-only basis to purchase a commercial property which is leased to a local auto-electrician. On 30 June 2020, the outstanding loan is $600,000. Terry retired on 1 June 2020 and has a total super balance of $800,000 which is used to pay a pension. Linda works as a florist and has a balance of $400,000 in her fund. As Terry has retired, a portion of the outstanding balance of the third-party borrowing will be included as a credit to his transfer balance cap. This will not occur with Linda as the loan was taken with a third-party lender and she has not retired or is over age 65. The amount that will be included in Terry’s transfer balance cap is calculated as the outstanding loan as at 30 June 2020 multiplied by Terry’s balance and divided by the total balances of Terry and Linda as members of the SMSF: = $600,000 x $800,000/$1,200,000 = $400,000

¶5-370 Trustee not to lend to members The trustee of the superannuation fund must not lend or provide any form of financial assistance to members or relatives of members of the fund under s 65 of the SISA. This provision is self-explanatory and applies even if the terms of the loan are commercial. The in-house assets test would also pick up this

loan; however, those rules allow up to 5% of the fund’s assets by way of in-house assets before a breach of that particular standard would occur. Refer to SMSF Ruling SMSFR 2008/1 for the ATO’s interpretation of what it considers is meant by the provision of financial assistance to members or relatives. Refer also to DFC of T (Superannuation) v Fitzgeralds and Anor 2007 ATC 5105; [2007] FCA 1602 which concerns the imposition of penalties under the civil penalty provisions for breaches of s 65 of the SISA.

¶5-380 All transactions to be on an arm’s length basis The trustee or investment manager must invest the money of the fund on an arm’s length basis (s 109 of the SISA). This does not preclude the trustee dealing with parties who are closely associated with the fund, subject to the other provisions of SISA; it merely requires that the transaction stands up to commercial tests. The case of the Australian Prudential Regulatory Authority v Derstepanian [2005] FCA 1121 is relevant here as it involved the sale of obsolete jewellery making machinery to the superannuation fund at an inflated price. Where there is a relationship between the trustee and the other party to the transaction, the ATO can be expected to pay close attention to the arrangement. The ATO writes extensively about arm’s length transactions in published audit guidelines on www.ato.gov.au/super. Example ATO example on arm’s length transactions The fund has purchased a commercial property from a member of the fund at market value for $1,000,000 and leases it back for $2,000 a year. There is no written lease agreement in place; however, the minutes of trustees’ meetings do include details of the arrangement. After the first year, the fund has not received any money from the member and has decided as a favour to the member to write off the $2,000 debt. Action required • As the commercial property purchased is “business real property” as defined under SISA s 66(5), there would be no contravention under SISA s 66 — the acquisition of assets from a related party. • As the property is classed as business real property, the lease between the trustees of the fund and the member, a related party of the fund, would not be considered to be an in-house asset, if throughout the term of the lease the property remained business real property of the fund within the meaning of SISA s 66(5). • As no formal written lease agreement exists between the fund and the member, the auditor should insist that a formal lease be drawn-up and executed by both parties, with the lease rental being established at market rates. • Arm’s length — the auditor reviews the rental of the property to determine if the $2,000 a year is a reasonable payment for the lease. • If the rental income is not considered to be in line with current market rates based upon rentals of similar properties in that locality, the auditor should inform the trustees, in writing, that he or she considers that they contravened SISA s 109 since the lease arrangement was not at arm’s length, as a consequence of the member receiving a favourable rental rate and because the debt had been written off as a favour to the member. • Even if the rental income is considered to be reasonable, the auditor will still need to write to the trustees of the fund advising that s 109 has been contravened by writing off the debt as a favour to the member. • The auditor should request a report from the trustees as to what action has or will be taken to rectify the contravention(s). • If the auditor is satisfied that the contravention(s) will be or has been rectified, including the repayment of any loss of interest, the auditor should report the contravention in the audit report. Also, depending upon the seriousness and materiality of the contravention, the auditor should determine whether a qualification in the auditor’s report is needed. • If the auditor does not receive a report from the trustees or is not satisfied with the action or proposed action of the trustees, the auditor must advise the ATO, in writing, outlining the details of the contravention and report the contravention in the audit report. Depending upon the seriousness and materiality of the contravention, the auditor will also need to determine whether a qualification is required.

In contrast to this example, ATO ID 2010/162 discusses the position where a loan made to an SMSF for purposes of a limited recourse borrowing arrangement is on terms more favourable to the trustee. The ATO considers that this situation does not result in a breach of the requirements that the parties be acting on an arm’s length basis. The reason is that s 109 prohibits the terms of the transaction to be more

favourable to the other party; however, the arrangement can be more favourable to the superannuation fund without breaching s 109. If the income is regarded as excessive it may be treated as non-arm’s length income under s 295-550 of the ITAA97 and taxed at 45%. One issue that needs to be considered is whether the benefit that the superannuation fund gains because of the more favourable terms could be treated as a contribution to the fund. This was considered in Private Binding Ruling 1012396819768 where it was held that the benefit to the fund did not constitute a contribution. What constitutes a contribution is discussed in Taxation Ruling TR 2010/1. The ATO has issued SMSF Regulator’s Bulletin SMSFRB 2020/1 on SMSFs investing in property development either directly or via interposed structures. They are concerned that some arrangements may be breaching the SISA, and income diverted to the SMSF could be excessive and taxable as nonarm’s length income. The bulletin focuses on property development involving limited recourse borrowing arrangements, joint ventures, partnerships as well as ungeared related party trusts and companies.

¶5-390 Trustee not to charge assets of the fund The trustee of a superannuation fund is not allowed to give a charge or provide security over an asset of the fund. A charge includes a lien, mortgage or any other encumbrance over the asset of the fund. Example The trustee of an SMSF is currently the owner of some real estate. It is not possible for the trustee to place a mortgage or a covenant over the property.

In the case of International Art Holdings Pty Ltd (admin apptd) & Ors v Adams & Ors 11 ESL 13; [2011] NSWSC 164, it was considered that a declaration by an administrator as a statutory or equitable lien over artworks owned by an SMSF for the administrator’s costs and expenses was permissible under the operation of the SISA. It is possible for a superannuation fund to acquire an asset which has a charge over it prior to acquisition and the charge remains over the asset subsequent to the acquisition. In practice this is unlikely to occur as the lender, such as a bank, would need to recognise the change in the legal owner of the asset. Refer to ATO ID 2011/81.

¶5-400 The SMSF investment strategy Although the investment objective and investment strategy are quite different in their purpose and use, they are difficult to separate. The reason is they are part of a process undertaken by the trustee to deliver something to a member of the fund — whether that member is taking a pension, accumulating their benefits in the fund for the purpose of taking a pension or seeking to maximise the benefits that may be distributed to dependants. The governing rules of the fund will provide an indication for the trustee and their SMSF adviser on investment objectives and investment strategies. Even if this is not the case, SISA provides a set of important rules around these two areas. This is also one instance where SISA overrides the governing rules of the fund, ensuring the trustee cannot escape investment planning in the fund. SISA s 52B(2)(f) provides that the trustee of the fund must formulate, give effect to and regularly review an investment strategy that has regard to the whole of the circumstances of the fund including, but not limited to, the following: • the risk involved in making, holding, realising, and the likely return of the fund’s investments having regard to its investment objectives and its expected cash flow requirements • the composition of the fund’s investments as a whole, including the extent to which the investments are diverse or involve the fund being exposed to risks from inadequate diversification • the liquidity of the fund’s investments having regard to its expected cash flow requirements, and

• the ability of the entity to discharge its existing and prospective liabilities. The ATO has released important guidelines in relation to investment objectives and investment strategies for trustees of an SMSF and their advisers (NAT 2063). The key obligations raised by the ATO concerning the fund’s investment objective and investment strategy are as follows: • The trustees of an SMSF are solely responsible and directly accountable for the prudential management of their members’ benefits. They can use an adviser, but, in the end, it is their responsibility as trustee. • As part of this prudential responsibility, the trustees of an SMSF are required to prepare and implement an investment strategy for the superannuation fund. • The strategy must reflect the purpose and circumstances of the fund and have particular regard to the membership profile, benefit structure, tax position and liquidity requirements of the fund. • An investment strategy should set out the investment objectives of the fund and detail the investment methods the trustees will adopt to achieve those objectives. • It is the trustees’ duty to make, implement and document decisions about investing fund assets and to carefully monitor the performance of those assets. • The trustees must ensure all investment decisions are made in accordance with the investment strategy. • The investment strategy must be regularly reviewed. • Insurance must be considered for members of the fund. • Breaches of the investment strategy requirement may result in the trustees being fined or sued for loss or damages. In addition, the fund could lose its complying status. The investment strategy — core components There are a number of key requirements in building an investment strategy to conform to the ATO’s guidelines. Those requirements can, for example, be broken down into six simple steps as follows. Six steps to an investment strategy Step 1 — the investment objective for the member or fund Step 2 — the portfolio allocation strategy to meet this objective Step 3 — the investment style for each asset class in the portfolio Step 4 — the investment types to be employed for the asset class Step 5 — the specific assets chosen for the investment type of the asset class Step 6 — consideration of insurance for members of the fund.

¶5-500 Acquisition of real estate by an SMSF SMSFs, like all types of superannuation funds, often have a portfolio which may include direct investment in real estate. There are a number of ways in which a property can be acquired and owned by an SMSF. The trustees of a superannuation fund may wish to acquire the real estate either directly from the market or related parties. Real estate purchased from the market has few restrictions under the SISA. However, attention should be paid to various fund documents such as the fund’s trust deed, investment strategy and the relevant legislation which may restrict the acquisition. In addition, s 66 of SISA restricts the type of real estate to be acquired from a related party such as a member, trustee or relative of a member or trustee.

In some circumstances a superannuation fund may wish to acquire only part ownership of the real estate rather than own all of it. Reasons for having part ownership may include the lack of resources in the fund to be used for investment or it may not be consistent with the fund’s investment strategy to purchase the whole property. Owning the property outright A superannuation fund may purchase all of a property. In these cases it must be ensured that the investment is consistent with the fund’s investment strategy and asset allocation. Any acquisition of the property must also be made on an arm’s length basis. To establish that the acquisition is on an arm’s length basis the trustees should ensure all transactions are recorded and all relevant documents retained by the fund. Ownership of the property with other parties There are two methods of owning property with others — tenants in common and joint tenancy. A tenant in common arrangement is where the owners of the property have rights to a distinct proportion of the property none of which can be physically identified. Joint tenancy is where each owner of the property does not own a clearly identified proportion of the property. On death, the joint tenant’s interest in the property ceases and ownership passes to the remaining owners. A superannuation fund owns property with other parties to the transaction usually as tenants in common and not as joint tenants. However, it is common that trustees of superannuation funds will own property in the capacity of trustee, either outright, in the case of a company, or as joint tenants where the trustees are individuals. The ATO are currently monitoring (search: Super Scheme Smart) arrangements involving SMSFs and related-party property development ventures for potential application of the non-arm’s length income (¶5380), and arrangements diverting rental income from commercial property to an SMSF by the SMSF member or related party granting a legal life interest over the property (but retaining legal title). Types of property The SIS legislation recognises two types of property that can be owned by the superannuation fund — business real property and any other property. Business real property is discussed by the ATO in SMSF Ruling SMSFR 2009/1 and is real estate used by anyone wholly and exclusively for business purposes. For example, if a property is used solely to operate one or more businesses then it will meet the definition of business real property. If the property is used partly for residential or private purposes, then it will not be regarded as business real property in most cases. Some incidental use of the property for private purposes may be acceptable in limited circumstances. There are two exceptions to the basic rule. This is where the property is used for primary production purposes such as a farm or part of the property is used for residential purposes as an integral part of running the business. In the case of a farm, an area of up to two hectares can be used for residential purposes and the farm will continue to be treated as business real property. An example of a residence forming an integral part of running the business would include a motel where the manager is usually required to live on the premises. There is no restriction to the proportion of the fund which can be invested in property. Therefore, it is possible for a fund to hold up to 100% of its investments in property although most superannuation funds hold less than this level. Mortgaging the property Under the SIS legislation, it is not permissible for a superannuation fund to borrow except in very limited circumstances and then only for short periods or for purposes of a limited recourse borrowing arrangement. It is not possible for the trustee to place a charge, such as a mortgage, over any property once ownership has been transferred to the fund. When a mortgage is placed over a property, a financial institution or other party places the mortgage over the title to the property and not the portion of the property held by each owner. Therefore, it is not possible for another owner to place a mortgage over the property without the fund being in breach of the borrowing

and charging of assets rules in SISA. However, it may be possible to have a property which is mortgaged transferred to the fund in accordance with the circumstances discussed in ATO ID 2011/81. The following flow chart should assist to determine whether a superannuation fund is able to acquire real estate:

¶5-600 Taxation of investments in an SMSF Tax on investments Each investment in an SMSF has its own taxation consequences for the trustee of the fund which is more important in the accumulation phase than the retirement phase. Consider some of the following typical investments in an SMSF. • Direct equities. Invaluable for imputation credits to limit the fund’s tax liability. The trustee of the fund obtains a 33⅓% (one-third) capital gains discount upon disposal of the investment if the asset has been held by the fund for longer than 12 months. This means that the effective tax payable by the fund on any capital gains for assets held for longer than 12 months is 10%. • Exchange traded equity funds. These are taxed like any investment company with dividends having imputation credits. Many exchange traded equity funds are listed securities for purposes of s 66 of

the SISA. • International shares. Any dividend is assessable to the trustee of the fund with a foreign tax credit available if withholding tax has been paid in the country of origin. No imputation credits are available on these shares. Any international investment carries with it the risk of currency exchange gains and losses. • Instalment warrants. The trustee of the fund can leverage the equity exposure and also the franking credits by using instalment warrants. The use of an instalment warrant is one of the only legitimate means possible for the trustee of the fund to leverage an investment and not contravene the rules precluding the trustee from borrowing. The amount of the underlying leverage in the instalment warrant will depend on the type of warrant. There are some warrants available with leverage as high as 80%. The trustee must be careful to write a risk management statement and be careful of the guidelines on the use of instalment warrants and other derivatives. • Private equity. Where a dividend is paid to the SMSF which is in excess of an arm’s length amount or the purchase price or expenses relating to the investment are not on an arm’s length basis, the whole dividend and any capital gains on the sale of the investment will be taxed as non-arm’s length income. Cases relating to excessive non-arm’s length income are: Darrelen Pty Ltd as Trustee of Henfam Superannuation Fund v FC of T 2010 ATC ¶20-180; [2010] FCAFC 35, Allen (Trustee), in the matter of Allen’s Asphalt Staff Superannuation Fund v Commissioner of Taxation 2011 ATC ¶20277; [2011] FCAFC 118, MH Ghali Superannuation Fund v FC of T 12 ESL 15; [2012] AATA 527, SCCASP Holdings as trustee for the H&R Super Fund v FC of T 2012 ATC ¶20-349; [2012] FCA 1052. There are also a number of Private Binding Rulings issued by the ATO on interest-free loans made to the fund as part of a limited recourse borrowing arrangement and the consideration of income received by the fund as being non-arm’s length income. Non-arm’s length income is taxed at a rate of 45% for the 2020/21 financial year and credit is given for any imputation credits on company dividends or trust distributions which include company dividends. • Property investment. Any rental income from property will be assessable income but the trustee can claim depreciation and capital allowances in the fund. However, the trustee must be careful not to let any related party stay in the property or the fund may breach the superannuation standards and could result in the trustee being penalised or the fund becoming a non-complying superannuation fund. • Bonds. The interest earned by the fund on a corporate bond is assessable income and any profit or loss on the disposal of the bond may be assessable income or deductible. • Cash. Interest on cash and fixed term deposits in an SMSF is assessable income.

Note Superannuation funds, including SMSFs, cannot treat shares, land and units as trading stock (see ¶4-320).

Tax for the accumulation side of the fund An SMSF may have two distinct groups of members — accumulation and retirement phase members (pension members). Retirement phase refers simply to someone who is in receipt of a retirement income stream from the fund. A TRIS is not considered to be in retirement phase until the pensioner satisfies a nil condition of release. In contrast, an accumulation phase member is a person in process of accumulating their retirement wealth from contributions and earning income on their fund balance in the SMSF. From a taxation perspective, the accumulation side of the fund is generally taxed at 15% on all taxable

income earned by the trustee of the fund. Taxable income is assessable income of the fund less any allowable deductions. Assessable income includes rent, dividends, interest, royalties, trust distributions and lease income. It also includes taxable contributions received by the fund, which are essentially contributions made by an employer or where the member has claimed a tax deduction. Capital gains earned by the trustee of the fund as part of the CGT cost base reset as at 1 July 2017 or in respect of the disposal of shares, units in a unit trust, property and any other CGT asset, after taking into account any capital losses of the fund, access a 33⅓% (one-third) discount. The discount is available 12 months after the date of the CGT cost base reset or the original acquisition date of the CGT asset, whichever applies in the circumstances. The net result is then transferred into the fund as assessable income. Expenses incurred in running and maintaining the fund are usually tax deductible. This includes professional fees paid to a financial planner, auditor, administrator or actuary. Generally initial expenses paid by the trustee to establish the fund, eg acquiring a trust deed, are non-deductible. However, where the trustee of the fund upgrades their trust deed to meet changes in SISA, such as amending the trust deed to provide for individual or corporate trustees due to the introduction of the SISA from 1 July 1994, the expense may be deductible. Taxation Rulings IT 2672 and TR 93/17 provide information concerning the tax deductibility of expenses of a superannuation fund. Tax on the pension side of the fund Once a member of the fund commences an income stream in retirement phase, the tax complexion of the fund changes dramatically. Where members take an income stream from the fund other than a TRIS or non-commutable allocated pension that is not in retirement phase, the trustee is exempt from tax on taxable income and capital gains on investments that are linked to the payment of income streams. How the tax exemption works depends upon the type of investment accounting process the trustee is using. The trustee must decide whether they should have all the investments pooled (unsegregated fund) or separate the members’ investment accounts and divide the fund investments into those that provide pensions in retirement phase and the remainder which relate to the accumulation phase (segregated fund) and TRISs that are not in retirement phase. Where at least one member of the SMSF has a total superannuation balance of at least $1.6m and the fund is wholly in pension phase or in accumulation and pension phase the SMSF is required to use the unsegregated method, also known as the proportional method, to determine its taxable and tax exempt income. Where this applies the fund is required to obtain an actuarial certificate for the period or periods during the year in which the fund is required to use the proportional method. Where the trustee of the fund uses a separate account and holds the assets solely for the purpose of paying a current pension, any income or capital gain earned on those pension assets is exempt from tax. Taxation Determination TD 2014/7 discusses the circumstances in which a single bank account of a fund can be treated as being separated to pay current pensions. An exception to the rule for tax exemption is that non-arm’s length income earned on pension assets and assets in accumulation phase is taxed at 45% for the 2020/21 financial year. Moving from the accumulation phase to the retirement phase If an SMSF member commences an income stream, but not a TRIS, at age 60 instead of taking benefits as a lump sum and the assets of the fund are determined on a segregated basis, the trustee of the fund will transfer, within the fund, some or all of the assets from the member’s accumulation account to the member’s retirement phase account in the fund. However, the value of the amount transferred to commence the retirement phase pension will depend on whether the member will be under their transfer balance cap, generally $1.6m. If the transfer balance cap is exceeded the ATO will issue a determination and impose an interest rate penalty on any excess. If a member of an SMSF has a total balance in all superannuation funds of greater than $1.6m, the fund will be required to use the unsegregated or proportional method to determine its taxable and tax exempt income. The transfer by the trustee from accumulation to retirement phase is not treated as the rollover of a superannuation benefit. This is discussed by the ATO in Taxation Determinations TD 2013/10 and TD 2013/11 in relation to death benefits credited to a beneficiary. Also, the transfer is not subject to CGT because the trustee of the fund, the owner of the assets, has not realised the assets, but merely accounted for them in a different way. From a practical point of view, the member may be given a

separate investment account statement showing income and capital gains earned on pension assets, any pension payments made, other expenses and, importantly, no tax to pay. Additionally, the member’s account may be credited with any imputation credits paid on shares in their account. At a later point in time when the trustee realises any of the assets in retirement phase, no tax will be payable by the trustee of the fund on the disposal of the asset if it uses the segregated method. If the fund uses the unsegregated or proportional method to determine its tax exempt income then the proportion which relates to retirement phase will be tax exempt. The exemption applies even though much of the gain may have accrued during a time when the member was in the accumulation stage. This is an added tax bonus to members and trustees who hold on to assets until commencement of an income stream in retirement phase. Not all trustees of funds run separate investment accounts when a member of the fund is in the retirement phase. For the trustee running a pooled account with accumulation and pension members, there is a proportional exemption of income and capital gains. This is also referred to as an unsegregated or pooled fund. To determine the tax exempt income of the fund the trustee engages the services of an actuary who calculates the proportion of the fund that has supported the provision of pensions in the fund as against the total value of the fund itself. Once this percentage is determined, the trustee then applies this proportion to exempt from tax a certain part of all of the fund’s income and capital gains. The actuarial certification must be made each year. The superannuation reforms which commenced on 1 July 2017 make it compulsory for certain SMSFs to use the proportional method to calculate the tax exempt income of the fund. These funds are not able to use the segregated method which identifies those investments solely supporting the retirement phase and those which are solely supporting the accumulation phase in the fund or the fund is providing only income streams in retirement phase. The proportional method is required to be used if the fund is an SMSF at any time during the financial year and any of the following apply: • at anytime during the financial year there is at least one superannuation interest in retirement phase • a member of the fund has a total superannuation balance in all superannuation funds that exceeds $1.6m on 30 June in the previous financial year and that member: – is in retirement phase in any superannuation fund of which they are a member, and – they are a member of the respective SMSF. A benefit is considered to be in retirement phase where a member is in receipt of a pension including account-based pensions, allocated pensions, lifetime and life expectancy pensions as well as term allocated pensions and market-linked income streams. Transition to retirement income streams and noncommutable allocated pensions are considered not to be in retirement phase since 1 July 2017 as the income earned by the fund on investments used to support them is taxed in the fund at 15%. However, if a TRIS meets one of four conditions of release as discussed previously it will be considered as being in retirement phase. The value of imputation credits In most cases, SMSFs do not pay much tax at all where they are invested in Australian companies that pay franked dividends. With a maximum franking credit of 30% and an SMSF tax rate of 15%, investing in Australian shares can be an effective tax strategy in itself. For SMSFs in the retirement phase where no tax is payable, the trustee is still able to claim imputation credits. This means more excess franking credits finding their way into the fund. Consider the following table, which highlights the receipt by the trustee of an SMSF of a franked dividend. SMSF position

Accumulation phase

Retirement phase

Cash dividend

$70

$70

Gross up — imputation credit

$30

$30

Assessable income

$100

$100

Less tax payable

($15)

($0)

Franking credit

$30

$30

Excess credit

$15

$30

Importantly, any excess credits that cannot be used in the current tax year are refundable. Given the premium value of imputation credits for the trustee of an SMSF, the trustee should give consideration to looking for imputation credits via direct equities, managed funds or instalment warrants.

¶5-700 SMSF reserves In very limited circumstances, an SMSF may use reserves to assist in ensuring the financial viability and soundness of a fund and the fund’s obligations to its members. The ATO has published SMSF Regulator’s Bulletin SMSFRB 2018/1 on the use of reserves which sets out its concerns on how reserves can and cannot be used by an SMSF. The ATO expects that reserves that are created or increased from 1 July 2017 will be used in limited circumstances for specific and legitimate purposes as authorised by the SISA. As a general rule, reserves that existed before 1 July 2017 will not be scrutinised by the ATO unless they are being used to circumvent restrictions imposed by the superannuation changes that commenced on 1 July 2017. What are reserves? Reserves are amounts set aside within the fund. Generally, amounts credited to a reserve are unallocated monies and do not form part of any individual member’s account. The only exception to the general rule is concessional and non-concessional contributions made to an unallocated contributions account which is subsequently transferred to the member’s account. The provisions of SISR reg 7.08 require contributions made to an accumulation fund to be allocated to members within 28 days after the end of the month in which they are made. Taxation Determination TD 2013/22 discusses the manner in which contributions made to an unallocated contributions account in the fund can be allocated to the member’s account. Example A two-member superannuation fund has a total of $100,000 in investments. Each member has a $45,000 balance in the fund and the fund holds $10,000 in reserves.

Superannuation funds can maintain reserves if the trust deed permits. The trust deed determines what types of reserves are allowed and how they can be used. If reserves are used the trust deed must have the appropriate wording. Types of reserves Reserves can be used for a range of purposes. Types of reserves include: • an investment reserve, which holds investment earnings and unrealised capital gains that have not been allocated to members’ accounts • a contributions reserve or unallocated contributions account, which holds unallocated contributions to the fund that are to be credited to member’s accounts, and • a miscellaneous reserve, which holds all other unallocated amounts. Although there are many different types of reserves that exist for various purposes and may have different names, all reserves can be grouped into the three categories listed above. A specific use of a reserve is an investment reserve. An investment reserve can provide members with an agreed return each year irrespective of actual investment returns of the fund. The return a member achieves each year is determined by a crediting rate established by the trustees. If the actual investment return of the fund is 10% and the trustees determine a crediting rate of 4% then members will have 4% credited to their

account. The remaining 6% is allocated to the investment reserve. The reserve may build up in value over time. How do reserves work? Money allocated to a reserve comes from a number of sources including: • investment earnings, including realised capital gains of the fund • monies left over at the end of a lifetime or life expectancy complying pension, and • unrealised capital gains of the fund. For example, instead of money being allocated to a specific member’s account, the amounts above may be allocated to a reserve. The use of reserves must take into account the general anti-avoidance rules in the Income Tax Assessment Act 1936 (Cth) (ITAA36) Pt IVA. If the prime purpose of the reserving strategy is to avoid tax then the anti-avoidance provisions may apply. ATO’s concerns over the use of reserves The ATO has two categories of concerns over the use of reserves — regulatory concerns and use of reserves to circumvent the superannuation changes which commenced on 1 July 2017. The regulatory concerns relate to whether the reserve is for purposes of s 115 of the SISA, whether it is consistent with the sole purpose test and the fund’s reserving strategy in s 52B(2)(g) of the SISA. The ATO also has concerns about the use of reserves and the circumvention of the superannuation changes which commenced on 1 July 2017. These relate to the potential use of reserves to manipulate a member’s total superannuation balance and/or a member’s transfer balance account to enable a member access to concessions relating to non-concessional contributions and the amount that can be used to commence and maintain pensions. The ATO indicates in SMSF Regulator’s Bulletin SMSFRB 2018/1 that it will scrutinise certain types of arrangements with a view to determining whether Pt IVA of the ITAA36 applies. The main types of arrangements of concern to the ATO include (but are not limited to): • the intentional use of a reserve to reduce a member’s TSB to enable them to make non-concessional contributions (“NCCs”) without breaching their NCCs cap • the intentional use of a reserve to reduce a member’s TSB below $500,000 in order to allow the member to access the catch-up concessional contributions arrangements from 1 July 2018 • the intentional use of a reserve to reduce the balance of a member’s TBA below the member’s transfer balance cap to allow the member to allocate a greater amount to retirement phase, which in turn results in a greater amount of earnings within the SMSF being exempt current pension income (“ECPI”), and • the intentional use of a reserve to reduce a member’s TSB below $1.6m in order to allow the SMSF to use the segregated method to calculate its exempt current pension income. The ATO will consider whether a tax benefit has been obtained in connection with a scheme and whether the main purpose of a person who participated in the scheme, or a part of it, was to enable a taxpayer to obtain that tax benefit. The ATO is currently monitoring (search: Super Scheme Smart: Individuals) arrangements where new reserves are created in the SMSF to circumvent the restrictions around total superannuation balance (¶4233) and transfer balance cap (¶4-227) measures effective from 1 July 2017. What are the benefits of reserves? One of the main benefits of reserves is considered to be the unallocated monies building up over time. The trustee may use the amount accumulated in a reserve to provide members with certain additional

benefits and services or fund expenses. Where amounts transferred from reserves are paid to a member or beneficiary or to a member’s account, they may be counted for the purposes of the concessional contributions cap under reg 291-25.01 of the Income Tax Assessment Regulations 1997. Transfers from reserves As a general rule, transfers from an unallocated contributions account to a member’s account will be included in their concessional contributions cap. However, non-concessional contributions made to the fund and transferred to an unallocated contributions account will be counted against the member’s nonconcessional contributions cap. The transfer of concessional and non-concessional contributions made directly to an unallocated contributions account are required to be transferred to the member’s account within 28 days after the end of the month in which the contribution was made. This is discussed by the ATO in Taxation Determination TD 2013/22 and ATO ID 2012/16 (now withdrawn). In some circumstances, other amounts transferred or paid from a reserve in the fund will be excluded from the concessional contributions cap. This will occur when the amount transferred: • to the member’s account is less than 5% of the balance of the member’s account at the time of transfer. Any allocation of the amount from the reserve must be made on a fair and reasonable basis so that no advantage is given to one member over another • is to satisfy a pension liability of the member. An example may include a member who has lived past their life expectancy • relates to the commutation of a pension which is to be used to commence a new income stream • relates to the commutation of a pension as a result of the death of the pensioner and the amount is being allocated for purposes of a death benefit pension, superannuation lump sum or superannuation death benefit • relates to that part of the transfer of a foreign superannuation fund payment which has been taxed in the fund • is from the rollover of an untaxed element which is taxable in the receiving fund, and • occurs in a constitutionally protected fund. A discussion of amounts transferred from reserves in relation to pensions is provided in ATO ID 2015/22. Counting amounts from reserves against the concessional contributions cap In determining the amount to be counted against the concessional contributions cap the amount allocated may be net of any tax payable. Where this occurs the amount is multiplied by 1.176 to gross up the allocation to include the effect of any tax liability to ensure consistent treatment of all amounts counted against the concessional contributions cap. Example Belinda’s employer has an obligation to contribute $1,000 to the superannuation fund. However, as an alternative the trustee of the fund allocates an amount from the fund’s reserve. The trustee allocates $850 to Belinda’s account, which is equivalent to the $1,000 contribution less tax of 15%. As the amount is required to be grossed up, the allocation from reserves is increased by multiplying the amount by 1.176. This will result in an amount of $1,000 being counted against Belinda’s concessional contributions cap.

¶5-720 Death benefit nominations and SMSFs It is possible for the governing rules of an SMSF to permit a binding death benefit nomination in accordance with the member’s instructions. There is no requirement that the binding death benefit nomination made by a member of an SMSF be in the form required by SISR reg 6.17A which applies to funds with five or more members. However, the fund’s trust deed may import those provisions where a

member makes a death benefit nomination. Any nomination as it relates to SMSFs may direct the trustees to pay benefits to dependants as a pension or lump sum or a combination of both. It may also require the trustee to pay a proportion of the death benefit or a particular amount to a dependant as defined under the SISA. The decision of the Queensland Supreme Court in Donovan v Donovan 09 ESL 04; [2009] QSC 26 is interesting from the point of view of whether a death benefit nomination is binding on the trustee. Other relevant cases concerning the impact of ineffective or invalid death benefit nominations include Katz v Grossman 05 ESL 17; [2005] NSWSC 934, Ioppolo & Hesford v Conti 15 ESL 03; [2013] WASC 38, Wooster v Morris [2013] VSC 594, Munro & Anor v Munro & Anor 15 ESL 04; [2015] QSC 61, Re Narumon Pty Ltd [2018] QSC 185 and Burgess v Burgess [2018] WASC 279. In contrast to the direction made by a member of an SMSF under s 58 of SISA, death benefit nominations for funds with five or more members are made under the provisions of s 59 of SISA. These provisions, coupled with the lapsing binding death benefit provisions under SISR reg 6.17A, are more stringent than a member of an SMSF making a direction in terms of s 58. The ATO’s interpretation of the provisions of s 58 and 59 of the SISA has been published in SMSFD 2008/3.

¶5-800 Providing SMSF advice Any strategic SMSF advice provided by an accountant, financial planner, proper authority holder of a dealer group or administrator is bound by the Corporations Act 2001. This requires the adviser to be licensed or acting as an authorised representative of an Australian Financial Services (AFS) licensee. There is a limited exception, which ceased on 30 June 2016, for recognised accountants under Corporations Regulations 2001 reg 7.1.29A where an accountant recommends a client establishes an SMSF. The exemption does not extend to making a contribution, commencing a pension or other SMSF financial services. The accountants’ exemption has been replaced completely from 1 July 2016 with a limited licensing arrangement that permits accountants and others who qualify to provide advice about SMSFs and a limited range of financial products such as insurance and simple managed investment schemes. Recognised accountants who have practice certificates and apply for the limited licence had up until 1 July 2016 to be treated as meeting the experience requirements of the limited licence. An accountant who does not have a practice certificate is required to meet various experience requirements to obtain a licence (see ¶8-250). In relation to financial planning, an application for an AFS licence by a planner must state the particular financial services they are seeking a licence for. In that regard a large percentage of applicants will seek to provide superannuation advice pursuant to the Corporations Act s 764A(1)(g). The provision of SMSF advice is a subset of superannuation advice. Licensees and their authorised representatives need to be aware the provision of SMSF advice and general superannuation advice may not be one and the same. The core difference is in terms of the type of advice provided to the client. For general superannuation advice (retail, industry or employer superannuation fund), the issue is mainly one of investment performance. In contrast, the provision of SMSF advice, in many instances, does not relate to investments at all. The adviser is concerned with specific compliance issues relevant to the client and how the SMSF can be structured or built to accommodate those specific issues. These include issues such as the trust deed, in-house assets, and appropriate compliance documentation. For example, let’s consider an accumulation member of an SMSF who has an account balance of $750,000. The SMSF adviser must contemplate the types of pension the trustee is able to provide to the member including a review of the trust deed, discussions with the actuary, preparation of relevant compliance documentation. For a detailed discussion on pensions, see Chapter 16. Certain decisions must be made by licensees and their authorised representatives including: • will the licensee allow any of their authorised representatives to provide strategic SMSF advice to

clients or restrict them to investment advice and investment strategies for the trustees of the funds? • will the licensee implement industry-endorsed standards when providing advice on SMSFs? • will licensees provide restricted advice for accountants seeking to provide only strategic advice to clients? • will the licensee require financial planners to complete any specific training to assess their competence to provide investment advice to trustees of an SMSF? Audit of SMSFs ASIC has a system for registration of SMSF auditors which is required under the provisions of the SISA. Auditors who apply for registration are required to sit the competency exam. In addition to the registration requirements, SMSF auditors must undertake 120 hours of continuing professional development (CPD) training over three years. SMSF auditors are also required to comply with the Accounting Professional and Ethical Standards Board’s APES 110 Code of Ethics for Professional Accountants as a condition of their registration. A fee payable at the time of registration as well as an annual fee is payable at the time the auditor lodges their annual statement with ASIC confirming they have met the ongoing requirements of registration.

SOCIAL SECURITY The big picture

¶6-000

What’s new and what’s proposed in social security? ¶6-050 Centrelink benefits Pensions, allowances and other benefits

¶6-100

Change of circumstances

¶6-120

Residential qualification for pensions

¶6-135

Age Pension

¶6-140

Carer Payment

¶6-160

Carer Allowance

¶6-170

Disability Support Pension

¶6-180

Residential qualifications for allowances

¶6-185

JobSeeker Payment

¶6-190

Partner Allowance

¶6-230

Parenting Payment

¶6-240

Austudy and Youth Allowance

¶6-250

Widow Allowance

¶6-270

Bereavement Payments

¶6-290

Summary of other pensions and allowances

¶6-300

Taxation of social security benefits

¶6-310

Pension Bonus Scheme

¶6-320

Rent Assistance

¶6-340

Family Assistance payments

¶6-350

Other Centrelink benefits

¶6-360

Department of Veterans’ Affairs benefits Overview of the Department of Veterans’ Affairs

¶6-400

Service Pension

¶6-420

Disability Pension

¶6-440

War Widow/er Pension

¶6-460

Concession cards

¶6-480

Means tests Means testing social security

¶6-500

Assets test

¶6-520

Income test

¶6-540

Housing in retirement

Pensions, the assets test and the family home

¶6-560

Assessment of investments Assessment rules

¶6-580

Financial assets and deeming

¶6-600

Superannuation

¶6-610

Private trusts and companies

¶6-620

Income streams

¶6-640

Treatment of property investments

¶6-660

Gifting rules

¶6-670

Waiting periods Waiting period rules

¶6-700

Ordinary waiting period

¶6-705

Compensation may affect social security

¶6-710

Liquid assets waiting period

¶6-720

Income maintenance period

¶6-730

Newly arrived residents waiting period

¶6-750

Strategies, tips and traps Social security strategies

¶6-800

Income test strategies

¶6-840

Assets test strategies

¶6-860

¶6-000 Social security

The big picture This chapter provides general information on eligibility for pensions, allowances and other benefits and means tests. Due to the ever-changing nature of social security legislation and the regular review of benefits and means tests, it is important to check for the latest information prior to giving advice to clients. Additional information can be obtained by contacting the Financial Information Service on 132 300. Alternatively, the Centrelink website (www.servicesaustralia.gov.au), Department of Veterans’ Affairs (DVA) website (www.dva.gov.au) and the My Aged Care website (www.myagedcare.gov.au) provide detailed and up-to-date information on benefits and legislative changes. What part do social security benefits play in the financial planning process? Social security benefits provide a “safety net” for people who have retired or cannot work and are unable to support themselves. Many clients who have not been able to accumulate substantial assets for retirement, or who are unemployed/unemployable for some reason, rely on government assistance. Self-funded retirees may also be looking to the government for some form of assistance by way of fringe benefits or to help them supplement their income in retirement. In the planning process, there are many strategies which can be employed to legally maximise or gain qualification for benefits for people who believe that benefits are not available to them. These

strategies are covered at the end of this chapter. For an adviser to successfully employ these strategies, they must understand the framework in which the social security system operates. There may also be cases where, through ignorance of the system (by the client or adviser), social security benefits are not claimed. Advisers need to keep abreast of developments in social security legislation to avoid financial disadvantage to their clients and possible legal ramifications. Steps in the process (1) First, an adviser needs to ascertain if a client may be entitled to a benefit under specified criteria such as residence, age, illness/disability, family situation, employment status or armed service record. The qualification criteria for each of the most commonly encountered social security benefits are set out. Common DVA benefits are also included. It may be necessary to check with Centrelink or DVA regarding eligibility, rates and means tests for these benefits .................................... ¶6-400 (2) Having established that a client is eligible for a benefit, the next step is to determine whether they may be precluded from receiving a benefit, or have their benefit reduced, due to the means tests. The two means tests applying to the calculation of benefits are the assets test and the income test. If a client is subject to both tests, the test that should be applied for calculating entitlement is the one that results in the lowest amount of benefit. Means test limits and methods of calculation are included .................................... ¶6-500 (3) Certain types of investments may be assessed differently under the means tests .................................... ¶6-580 (4) There may also be cases where a person who qualifies for a benefit may be subject to a preclusion period due to the receipt of a compensation payment, or waiting periods based on the amount of liquid assets held at the time of application, or payments such as holiday pay or long service .................................... ¶6-700 Examples have been used wherever possible to assist with making calculations. Summary of information provided • Outline of the range of pensions and allowances most commonly encountered by advisers and summary of other benefits .................................... ¶6-100 • Outline of DVA benefits and payments which may be payable to veterans, members of the defence force and their families .................................... ¶6-400 • Guide to the operation of means tests, current limits and methods of calculation .................................... ¶6-500 • Methods of assessment for various types of investments .................................... ¶6-580 • Guide to current assessment of various forms of income streams such as pensions and annuities under the income and assets tests .................................... ¶6-640 • Outline of how to calculate preclusion, waiting or non-payment periods .................................... ¶6700 • Strategies, tips and traps .................................... ¶6-800

¶6-050 What’s new and what’s proposed in social security? Expanded access to income support payments due to COVID-19

As a result of the financial impacts of COVID-19, the government expanded access to a number of income support payments including JobSeeker Payment (formerly Newstart Allowance). Expanded qualification criteria applies to JobSeeker Payment and Youth Allowance (other) from 25 March 2020 to 31 December 2020: • access to people who have been stood down, become unemployed or had a reduction in working hours due to COVID-19 • sole traders or self-employed people whose business was suspended or suffered a reduction in turnover due to COVID-19 • people in quarantine or self-isolation or caring for someone with COVID-19. Where a person qualifies for JobSeeker Payment and is in severe financial hardship, they may also be entitled to a one-off Crisis Payment where they need to self-isolate, or they are caring for someone who needs to self-isolate due to COVID-19. As well as expanding the qualification criteria, the government also introduced the following temporary measures: • faster claim process including temporary removal of the requirement for an Employment Separation Certificate, proof of rental arrangements and verification of relationship status • changes to mutual obligation requirements, including sole traders and self-employed people being able to meet mutual obligation requirements by continuing to operate their businesses • removal of the assets test for JobSeeker Payment, Youth Allowance, Parenting Payment and Austudy from 25 March to 24 September 2020 • reduction in the partner income test taper rate from 60 to 25 cents for JobSeeker Payment which increases the partner income cut-off to $3,070.80 per fortnight or $79,840.80 per annum (where personal income is below $106 per fortnight and the partner is not receiving a pension) from 27 April to 24 September 2020. From 25 September to 31 December 2020, the partner income test taper rate reduction will be increased from 25 to 27 cents • increase in the personal income test free area for JobSeeker Payment and Youth Allowance (other) from 25 September to 31 December 2020. The income free area will increase from $106 to $300 per fortnight. Income over $300 per fortnight reduces the rate by 60 cents in the dollar • waiver of a number of waiting periods, including the Ordinary Waiting Period, Seasonal Work Preclusion Period and Newly Arrived Residents Waiting Period (NARWP) until 31 December 2020. The Liquid Assets Waiting Period is also waived from 25 March to 24 September 2020. This applies to JobSeeker Payment, Youth Allowance, Parenting Payment, Austudy, Special Benefit and Farm Household Allowance • access to an additional COVID-19 supplement of $550 per fortnight from 27 April to 24 September 2020. From 25 September to 31 December 2020, this will reduce to $250 per fortnight. All new and existing people receiving for JobSeeker Payment, Youth Allowance, Austudy, ABSTUDY, Parenting Payment, Farm Household Allowance and Special Benefit receive the supplement. $750 economic support payments As part of the government’s economic response to COVID-19, two separate $750 lump sum payments were paid to people receiving eligible payments or concession cards. • First $750 payment was paid from 31 March 2020 • Second $750 payment was paid from 13 July 2020 Eligible payments and concession cards included Age Pension, Disability Support Pension, Carer

Payment, Parenting Payment, Family Tax Benefit, Pensioner Concession Card holders, Commonwealth Seniors Health Card holders and people receiving entitlements from the Department of Veterans Affairs. In addition, people receiving payments that qualify for the COVID-19 Supplement of $550 per fortnight may have been eligible to receive the first $750 payment; however, they were not eligible to receive the second $750 payment. JobKeeper Payment To assist businesses impacted by COVID-19 cover the costs of their employees’ wages, the government introduced a $1,500 per fortnight wage subsidy called “JobKeeper Payment” for eligible employers. JobKeeper Payment commenced on 30 March 2020 and was scheduled to end on 27 September 2020. However, the government has announced it will be extended to 28 March 2021, with a tapered reduction in the payment rate. To be eligible for the scheme, a business must suffer a substantial decline in turnover. Until 27 September 2020, it is a condition of entitlement that the business has paid salary and wages of at least $1,500 to the employee in the fortnight. If the eligible employee is paid more than $1,500 a fortnight before tax, the employer will only be reimbursed $1,500 per fortnight. A business can also be entitled to a JobKeeper Payment of $1,500 per fortnight for one business participant who is actively engaged in operating the business. Under the extension to JobKeeper from 28 September 2020, a two-tiered level of support has been proposed: • Phase 1 (28 September 2020 to 3 January 2021): – $1,200 per fortnight — employed for 20 or more hours per week – $750 per fortnight for other eligible employees • Phase 2 (4 January 2021 to 28 March 2021): – $1,000 per fortnight — employed for 20 or more hours per week – $650 per fortnight for other eligible employees. Individuals receiving an income support payment such as JobSeeker Payment who commence receiving JobKeeper Payment must notify Centrelink. JobKeeper Payment will be included in assessable income for the income test. Changes to reporting employment income delayed Legislation changing the way employment income is reported to Centrelink was scheduled to commence 1 July 2020; however, due to COVID-19, the government has delayed the commencement to 7 December 2020. Under current rules, employment income is assessed in the instalment period in which it is earned, derived or received. In practice, because employment income is usually earned before it is paid, a person is required to estimate and report the amount of employment income they have earned in an instalment period, which may result in over or under payments of social security entitlements. The changes to the reporting of employment income, which will now commence from 7 December 2020, are aimed at ensuring that employment income is assessed once it is paid. Under this system, Services Australia will use data collected by the ATO, primarily through the Single Touch Payroll (STP) system. Farm Household Allowance extended Farm Household Allowance (FHA) provides income support to farmers in financial hardship. From 11 June 2020, the following changes were made: • A new combined assets test, which amalgamates farm and personal assets under a single $5.5m limit, was introduced.

• An FHA eligible person’s income will not impact the rate of FHA payable. • The maximum amount of activity supplements was increased to $10,000. Changes to Parental Leave Pay For babies born or adopted before 1 July 2020, Parental Leave Pay is payable for a continuous block of up to 18 weeks. However, under new rules which apply to babies born or adopted on or after 1 July 2020, Parental Leave Pay may include both: • a continuous Paid Parental Leave period of up to 12 weeks • 30 Flexible Paid Parental Leave days. Flexible Paid Parental Leave days must be taken before the child turns two. Proof of life certificate for 80+ year olds living overseas From 20 December 2019, clients aged 80 and over who receive a Centrelink pension overseas will need to complete a proof of life certificate every two years to continue receiving their payment. The certificate must be signed by an authorised certifier. Department of Human Services is now called Services Australia On 1 February 2020, the Department of Human Services became “Services Australia”. Services Australia delivers Medicare, Centrelink and Child Support payments and services.

CENTRELINK BENEFITS ¶6-100 Pensions, allowances and other benefits Centrelink administers pensions, allowances and other benefits to eligible persons. Its focus is to provide income security for retired, sick or unemployed people and assistance for families with children. Pensions and allowances are subject to income and assets tests (¶6-500). Pensions, allowances and other benefits will only be payable if a person meets the qualification criteria. Generally, social security payments require a recipient to satisfy certain residential requirements, although there are some exemptions (¶6-120). Each type of payment has its own eligibility rules and this section provides an overview of the pensions, allowances and benefits and their respective qualification criteria which are of most importance to financial planners. Intent to claim From 1 July 2018, the intent to claim provisions was removed for most clients. Under these provisions, social security payments and concession cards were backdated to the day the client first contacted Centrelink provided all required information was provided within a specified timeframe. From 1 July 2018, only clients in “vulnerable circumstances” have access to the intent to claim provisions. For all other clients, social security payments or concession cards will be paid from the date a completed claim form is provided. A claim is complete when the required documentation specified in the claim and within the person's control is included with the claim. Online services Clients can access many Centrelink payments and services via www.servicesaustralia.gov.au including the: • Payment and service finder — determines the rate and type of payments and services that are applicable based on the individual’s circumstances including age, work status, study, children, health, etc

• Compensation — estimates if a compensation amount will affect a payment • Online accounts — all Centrelink online accounts are accessible through www.my.gov.au. The following services are available: – claim a range of Centrelink payments – report employment income – receive online letters – submit and request documents – tell Centrelink that you are travelling overseas – replace concession or health care card. The government has also introduced measures to streamline the online claims process for the Age Pension (¶6-140). Clients can also access Centrelink services through the Express Plus Centrelink mobile app.

¶6-120 Change of circumstances A person receiving a social security pension, benefit or concession card must notify Centrelink of any changes in their circumstances within 14 days. Some examples of changes in circumstances that must be notified include: • changes in personal and contact details • changes in bank details • changes in relationship status • changes in care arrangements • changes in work status • receiving a lump sum payment • changes in income or assets including the partner’s income and assets • starting or finishing studying • going overseas. If a change of circumstances is not notified within 14 days and the person subsequently receives a higher rate of social security payment, an overpayment may be raised and the person will have to repay the funds. In some cases, clients may be prosecuted where it can be shown they acted fraudulently or intentionally withheld information.

¶6-135 Residential qualification for pensions A basic requirement for social security pensions is that a person meets the residential qualifications by being: • in Australia at the time of applying for a payment • an Australian resident for more than 10 years, with at least five years of continuous residence.

An Australian resident is a person who resides in Australia and is either an Australian citizen or holds either a permanent resident visa or a special purpose/category visa and is likely to remain permanently in Australia. Exemptions The exemptions to the basic residential criteria include the following: • if an Australian resident is residing in a country with which Australia has negotiated a reciprocal agreement on social security matters, that person may be eligible for a payment. See section on “International agreements” below for more information. • applicants may qualify for a “qualifying residence exemption” if they reside in Australia and are either a refugee or former refugee. • if a person was receiving a Widow B Pension, a Widow Allowance, a Mature Age Allowance or a Partner Allowance immediately before reaching pension age, the person may automatically qualify for the Age Pension. • where a couple are both Australian residents and the woman’s partner dies, she may be entitled to a benefit provided she was an Australian resident for a continuous period of at least 104 weeks immediately prior to making the claim. • where a woman immediately before 20 March 2020 received Wife Pension (and was not receiving Carer Allowance) and reached pension age, she may automatically qualify for the Age Pension. International agreements Australia currently has 32 bilateral international social security agreements. Under these agreements, Australia equates social insurance periods/residence in those countries with periods of Australian residence in order to meet the minimum qualifying periods for Australian pensions. The other countries generally count periods of Australian working life residence as periods of social insurance in order to meet their minimum qualifying periods for payment. Usually, each country will pay a part pension to a person who has lived in both countries. Australia currently has reciprocal social security agreements with Austria, Belgium, Canada, Chile, Croatia, Cyprus, Czech Republic, Denmark, Estonia, Finland, Germany, Greece, Hungary, India, Ireland, Italy, Japan, Korea, Latvia, Malta, the Netherlands, New Zealand, North Macedonia, Norway, Poland, Portugal, Slovak Republic, Slovenia, Spain, Switzerland and the United States.

Note The social security agreement with the UK has been terminated. UK migrants who arrived in Australia after 1 March 2000 and apply for a pension after 1 March 2001 are unable to access the Age Pension from Australia without meeting the residence requirements.

¶6-140 Age Pension To qualify for the Age Pension, a person must satisfy the residential qualifications and have reached pension age. The following table illustrates Age Pension age for both men and women as determined by their date of birth. Date of birth …

Pension age

Prior to 1 July 1952* 1 July 1952 and 31 December 1953 1 January 1954 and 30 June 1955 1 July 1955 and 31 December 1956 1 January 1957 onwards

65 65½ 66 66½ 67

*Note: Age Pension age for women born before 1 January 1949 was less than age 65.

The rates of payment of the Age Pension are included at ¶20-460. Age Pension is subject to both the income test (¶6-540) and the assets test (¶6-520). Age Pensioners who are permanently blind are exempt from the income and assets test. The Age Pension is taxable. $750 economic support payments As part of the government’s economic response to COVID-19, two separate $750 lump sum payments were paid to people receiving the Age Pension: • First $750 payment was paid from 31 March 2020 • Second $750 payment was paid from 13 July 2020. An individual can be eligible to receive both the first and second payment. However, they can only receive one $750 payment in each round of payments. Pension supplement Age pensioners are eligible to receive a pension supplement, which replaced the pharmaceutical allowance, utilities allowance, GST supplement and telephone allowance from 20 September 2009. Pensioners have the option of receiving the pension supplement quarterly or fortnightly. Energy supplement Age Pension recipients receive an energy supplement paid as part of their regular pension payments. It was originally intended to assist with the inflationary impacts of the carbon tax. Since 1 January 2015, the energy supplement has been frozen at the 20 September 2014 rate. Transitional arrangements A number of changes to the Age Pension occurred from 20 September 2009 including an increase in the base rate for single pensioners, a change in indexation to either PBLCI (Pensioner and Beneficiary Living Cost Index) or MTAWE (Male Total Average Weekly Earnings) and an increase in the income test taper from 40 cents to 50 cents. Existing part pensioners who would have been adversely affected by the changes are saved under transitional provisions, allowing them to keep existing entitlements maintained in real terms. They will continue to receive these existing entitlements until they are better off under the new pension rules. Work Bonus The Work Bonus applies to pensioners of Age Pension age to encourage paid employment by reducing the amount of employment income included under the social security income test. From 1 July 2019, the Work Bonus was expanded to include income from self-employment that involves “gainful work”. In addition, the amount of Work Bonus increased from $250 to $300 per fortnight and the amount that can be accumulated in the income concession bank increased from $6,500 to $7,800. Employment income The Work Bonus applies to income from employment that is earned, derived or received in a 14-day instalment period, including:

• wages paid in Australia and outside Australia • leave, where the pensioner remains an employee of the same employer, and • director’s fees. Self-employment income From 1 July 2019, the Work Bonus applies to “gainful work” income, which is income from selfemployment for financial gain or reward, where the work involves personal exertion. Examples include operating a business as a plumber, farmer, wedding celebrant or artist. Gainful work income includes where the business is operated as a sole trader, partnership, private trust or company. It also includes work undertaken as an independent contractor. As gainful work income requires personal exertion, it does not include income from passive investments such as rent or investment income. In addition, the following activities also do not qualify as gainful work income: • managing or administering financial investments and real property, such as an investment property, owned by the person or their family, including a family company, family group or family trust • work involving domestic, household, gardening or similar tasks at the person’s place of residence. Where a business has a combination of gainful work income and passive income, only the gainful work income is eligible for the Work Bonus. For example, if a person received a $10,000 distribution from a trust, the Work Bonus would only apply to the extent that the person could show they had performed work commensurate to the amount paid. The Work Bonus applies to the amount of self-employment income from gainful work in a 14-day instalment period. However, income from self-employment is assessed and recorded on an annual basis, generally based on the financial statements from the previous financial year. In this case, the annual rate of gainful work from self-employment needs to be converted into an amount for each 14-day instalment period using the following formula: Annual amount/364 × 14 Example Joe operates a business as a wedding celebrant and has an annual rate of self-employment income from gainful work of $20,000. To determine the amount assessable in a 14-day instalment period, the annual rate is divided by 364 and then multiplied by 14: $20,000/364 × 14 = $769.23 Assuming Joe has no accumulated amounts in his income concession bank, the amount included in his assessable income will be reduced by the Work Bonus of $300: $769.23 − $300 = $469.23 In this case, $469.23 is included in assessable income in the instalment period.

The Work Bonus applies to Centrelink pensioners of Age Pension age or DVA pensioners of service pension age receiving the Service Pension or Income Support Supplement. Claiming the Age Pension online The government has streamlined the Age Pension online claim process. Online applications automatically save as they are being completed, meaning people can come back and finish their claim later, when they have all the right information. A person already receiving a Centrelink payment will have their existing financial information prepopulated into the online claim — which they can confirm or update as necessary. Paper forms are still available on the department’s website for those who are unable to use the online option.

¶6-160 Carer Payment A person will qualify for Carer Payment if: • the carer personally provides constant care to a disabled child or adult in the disabled person’s private residence • the disabled person is receiving a social security payment, a Service Pension or income support payments or meets the care receiver income and assets tests, and • the carer is living in Australia and is an Australian citizen, or a permanent resident (a 104-week waiting period may apply for recent migrants). Carer Payment is generally paid where a person requires care for six months or more unless the condition is terminal. There are six types of care receivers: • a higher ADAT (Adult Disability Assessment Tool) score adult (see below), or • a lower ADAT score adult (see below) and the dependent child of a lower ADAT score adult, or • a child with a severe disability or severe medical condition, or • two or more children with a disability or medical condition, or • one or more children each with disability or medical condition and a lower ADAT score adult (multiple care), or • a child with a terminal condition. A person meets the definition of a higher ADAT score adult where they: • require constant care (see definition below), and • assessed and rated using the ADAT and given a score of at least 25 (if only one person is caring for them), or • assessed and rated using the ADAT and given a score of at least 80 (if more than one person is caring for them). A person meets the definition of a lower ADAT score adult where they: • require constant care (see definition below), and • assessed and rated using the ADAT and given a score of at least 20. “Constant care” is care on a daily basis for a “significant period” during each day which is at least the equivalent of a normal working day in personal care. The care may be active, supervisory or monitoring. It is not necessary for the carer to live with the disabled person. The person being cared for needs to receive a pension or benefit, or: • be ineligible only because they have not lived in Australia long enough • meet special income and assets test limits. The carer cannot claim the Carer Payment in addition to another social security pension or benefit. However, Carer Allowance (see below) may be payable. The Carer Payment is paid at the pension rate (¶20-460) and is also subject to the pension income and assets tests (see ¶6-540 and ¶6-520 respectively).

A carer can retain the Carer Payment where they take up to 63 days each calendar year as respite. The Carer Payment is not taxable if the carer and the person being cared for are under Age Pension age and the person being cared for is receiving a non-taxable pension. Carers Supplement Carers Supplement is an ongoing, non-taxable payment which provides: • $600 per annum to Carer Allowance recipients for each person being cared for, and • $600 per annum to Carer Payment recipients. Those who receive Carer Allowance and Carer Payments will be eligible for both payments. Child Disability Assistance Payment of $1,000 per annum for carers who are paid Carer Allowance (child) is also payable. $750 economic support payments As part of the government’s economic response to COVID-19, two separate $750 lump sum payments were paid to people receiving Carer Payment: • First $750 payment was paid from 31 March 2020 • Second $750 payment was paid from 13 July 2020. An individual can be eligible to receive both the first and second payment. However, they can only receive one $750 payment in each round of payments.

¶6-170 Carer Allowance The Carer Allowance is paid to a person who provides daily care for either an adult or a child who is frail, chronically ill or disabled, and is being nursed at home. A carer who is providing care for a child under 16 years who receives Carer Payment, generally receives Carer Allowance automatically. In other cases, a claim is required. Carers are not required to reside in the same home as the person they provide care for to receive Carer Allowance. To be eligible, they will need to provide at least 20 hours per week of personal care. The Carer Allowance is $131.90 per fortnight as at 1 January 2020 (indexed annually). The payment is not taxable and is not assets tested, however an income test applies from 20 September 2018, see below. The Carer Allowance can be paid in addition to the Carer Payment, Age Pension or Parenting Payment. Carer Allowance income test From 20 September 2018, the combined income of the carer and their partner must be under $250,000 per annum. The income test for Carer Allowance is similar to the income test for the Commonwealth Seniors Health Card. Income includes the carer and their partner’s adjusted taxable income for the previous financial year as well as deemed income from account based pensions where the recipient is age 60 or over. $750 economic support payments As part of the government’s economic response to COVID-19, two separate $750 lump sum payments were paid to people receiving Carer Allowance: • First $750 payment was paid from 31 March 2020 • Second $750 payment was paid from 13 July 2020. An individual can be eligible to receive both the first and second payment. However, they can only receive one $750 payment in each round of payments.

¶6-180 Disability Support Pension To qualify for a Disability Support Pension (DSP) a person must: • be assessed as not being able to work or be retrained for work of at least 15 hours per week within two years because of illness, injury or disability, or • be permanently blind, or • be participating in the Supported Wage System (SWS) • be over 16 years of age and under pension age, and • satisfy the residency requirements. New DSP claimants who do not have a severe impairment must demonstrate that they have actively participated in a program of support. A program of support is designed to assist in preparation for finding and maintaining employment. Manifest grants A manifest grant of DSP can be granted in limited circumstances where it is recognised that the client has a severe medical condition that causes a continuing inability to work. A person can qualify for DSP under manifest grounds based on providing the required medical evidence without the need for further medical assessment. Manifest grants may only be made where a person: • has a terminal illness (life expectancy of less than two years with significantly reduced work capacity during this period) • has permanent blindness • has an intellectual disability where supporting evidence clearly indicates an IQ of less than 70 • has an assessment indicating the person requires nursing home level care • has category 4 HIV/AIDS, or • is in receipt of a DVA disability pension at special rate (totally and permanently incapacitated (TPI)). Allowable hours of work for DSP recipients From 1 July 2012, DSP recipients continue to receive DSP if they obtain paid work of at least 15 and less than 30 hours a week. Prior to 1 July 2012, DSP recipients granted on or after 11 May 2005 and transitional DSP recipients had their payments suspended or cancelled if they were working 15 hours a week or more. The rate of payment varies according to the person’s age (21 or over, see ¶20-460) and family situation. The pension income and assets tests apply. The DSP is not taxable where the client is under Age Pension age. $750 economic support payments As part of the government’s economic response to COVID-19, two separate $750 lump sum payments were paid to people receiving Disability Support Pension: • The first $750 payment was paid from 31 March 2020. • The second $750 payment was paid from 13 July 2020. An individual can be eligible to receive both the first and second payment. However, they can only receive one $750 payment in each round of payments.

¶6-185 Residential qualifications for allowances From 1 January 2019, the NARWP was increased from two to four years for Youth Allowance, Austudy, JobSeeker Payment, Special Benefit and Mobility Allowance. The increased waiting period applies to people who were granted permanent or applicable temporary visas on or after 1 January 2019. During this period of time, the allowance is not payable. Temporary suspension of NARWP Due to the COVID-19 pandemic, the government suspended the NARWP from 25 March 2020 to 31 December 2020 for the following payments: • JobSeeker Payment • Youth Allowance • Parenting Payment • Austudy • Special Benefit • Farm Household Allowance. Payments while overseas As with pension payments, an allowance recipient must be living in Australia when the payment claim is lodged. Most allowances are only payable for six weeks while temporarily overseas. The person must continue to qualify for the allowance during the period overseas. For allowances such as JobSeeker Payment, this would not be possible due to the activity test.

¶6-190 JobSeeker Payment JobSeeker Payment replaced Newstart Allowance From 20 March 2020, Jobseeker Payment replaced Newstart Allowance and Sickness Allowance to become the main payment available to working age people. Jobseeker Payment has the same basic qualification as Newstart Allowance; however, the payment includes access for people who have temporarily stopped working or studying to recover from illness or injury. In addition, Jobseeker Payment replaced Bereavement Allowance to provide bereavement assistance for people who have recently experienced the death of their partner. Qualification Under the standard eligibility criteria for JobSeeker Payment, an individual must: • be aged between 22 and age pension age • meet Australian residence requirements, and • be unemployed, or – unable to work due to a medical condition, illness or injury, or – employed or studying fulltime and unable to undertake these due to a medical condition, illness or injury and have a job or study to return to, and • satisfy mutual obligation requirements including entering into a JobPlan (if required). Expanded eligibility criteria due to COVID-19

Due to the economic impacts of COVID-19, from 25 March to 31 December 2020, the eligibility criteria for JobSeeker Payment has been expanded. Under the expanded criteria, an individual is eligible for JobSeeker Payment where the following occur as a result of the adverse economic effects of COVID-19: • If an individual loses their job. • If an individual’s working hours have been reduced. • If a self-employed person’s (or a sole trader’s) business was suspended or suffered a reduction in turnover. In addition, people whose working hours are reduced (including to zero) as a result of being in quarantine or self-isolation due to advice from a health professional regarding COVID-19 are also eligible. This includes the situation in which they are caring for an immediate family member or a member of their household who is in quarantine or self-isolation. Where a person qualifies for JobSeeker Payment and is in severe financial hardship, they may also be entitled to a one-off Crisis Payment where they need to self-isolate, or they are caring for someone who needs to self-isolate due to COVID-19. As well as expanding the qualification criteria, the government also introduced the following temporary measures: • faster claim process including temporary removal of the requirement for an Employment Separation Certificate, proof of rental arrangements and verification of relationship status • changes to mutual obligation requirements, including sole traders and self-employed people being able to meet mutual obligation requirements by continuing to operate their businesses • removal of the assets test from 25 March to 24 September 2020 • reduction in the partner income test taper rate from 60 to 25 cents which increases the partner income cut-off to $3,070.80 per fortnight or $79,840.80 per annum (where personal income is below $106 per fortnight and the partner is not receiving a pension) from 27 April to 24 September 2020. From 25 September to 31 December 2020, the partner income test taper rate reduction will be increased from 25 cents to 27 cents • increase in the personal income test free area from 25 September to 31 December 2020. The income free area will increase from $106 to $300 per fortnight. Income over $300 per fortnight reduces the rate by 60 cents in the dollar • waiver of a number of waiting periods, including the Ordinary Waiting Period, Seasonal Work Preclusion Period and Newly Arrived Residents Waiting Period (NARWP) until 31 December 2020. The Liquid Assets Waiting Period is also waived from 25 March to 24 September 2020. • access to an additional COVID-19 supplement of $550 per fortnight from 27 April to 24 September 2020. From 25 September to 31 December 2020, this will reduce to $250 per fortnight. Employees The expanded eligibility criteria means that employees, including permanent fulltime and part-time employees, casual employees and contractors, may be eligible for JobSeeker Payment where the following situations occur as a result of the adverse economic effects of COVID-19: • stood down • lost their job • working hours reduced.

It is important to note that there is no requirement for working hours to be reduced by a specific amount or percentage. However, JobSeeker Payment is subject to an income test. If a person’s working hours are reduced as a result of the economic impacts of COVID-19, the person must take reasonable steps to access any leave payments they are entitled to. If they receive leave payments when applying for JobSeeker Payment, the Income Maintenance Period will apply. Self-employed Under the standard activity testing requirements for JobSeeker Payment that applied before the COVID19 changes, self-employment satisfied the “sufficient work test” requirements if the person was working the required number of hours and the taxable income of the business provided the equivalent of the national minimum wage rate for the minimum required hours. Where self-employment did not satisfy the sufficient work test, the person was required to look for alternative work and/or undertake additional requirements to meet their mutual obligations. However, under the temporary expansion of the eligibility criteria due to COVID-19 these mutual obligation requirements have been removed to allow sole traders and self-employed people to continue operating their business while receiving JobSeeker Payment. To qualify under the expanded criteria, the business must be suspended, or suffered a reduction in turnover, due to the economic impacts of COVID-19. What if they receive JobKeeper Payment? To assist businesses impacted by COVID-19 cover the costs of their employees’ wages, the government introduced a $1,500 per fortnight wage subsidy called “JobKeeper Payment” for eligible employers. JobKeeper Payment commenced on 30 March 2020 and was scheduled to end on 27 September 2020. However, the government has announced it will be extended to 28 March 2021, with a tapered reduction in the payment rate. To be eligible for the scheme, a business must suffer a substantial decline in turnover. Until 27 September 2020, it is a condition of entitlement that the business has paid salary and wages of at least $1,500 to the employee in the fortnight. If the eligible employee is paid more than $1,500 a fortnight before tax, the employer will only be reimbursed $1,500 per fortnight. A business can also be entitled to a JobKeeper Payment of $1,500 per fortnight for one business participant who is actively engaged in operating the business. Under the extension to JobKeeper from 28 September 2020, a two-tiered level of support has been proposed: • Phase 1 (28 September 2020 to 3 January 2021): – $1,200 per fortnight — employed for 20 or more hours per week – $750 per fortnight for other eligible employees • Phase 2 (4 January 2021 to 28 March 2021): – $1,000 per fortnight — employed for 20 or more hours per week – $650 per fortnight for other eligible employees. Individuals receiving an income support payment such as JobSeeker Payment who commence receiving JobKeeper Payment must notify Centrelink. JobKeeper Payment will be included in assessable income for the income test. Temporary removal of waiting periods As part of the expanded eligibility criteria for JobSeeker Payment, the following waiting periods have been temporarily waived:

• Ordinary Waiting Period — The ordinary one week waiting period has been waived for people claiming JobSeeker Payment from 12 March to 31 December 2020. • Liquid Assets Waiting Period — The Liquid Assets Waiting Period has been waived from 25 March to 24 September 2020. • Seasonal Workers Preclusion Period — Prior to COVID-19 waivers, the Seasonal Workers Preclusion Period applied where a person applying for JobSeeker Payment or their partner finished seasonal, contract or intermittent work within 6 months of submitting their claim. From 25 March to 31 December 2020, this waiting period is waived. • Newly Arrived Residents Waiting Period — The NARWP is waived for people applying for JobSeeker Payment from 25 March to 31 December 2020. After 31 December 2020, those people who were serving a NARWP will continue to serve the remainder of their waiting period, though the time the person was receiving the COVID-19 supplement will count towards their NARWP. Changes to income and assets tests Under the temporary changes to JobSeeker Payment, the assets test has been removed from 25 March to 24 September 2020. The assets test has been removed for all JobSeeker Payment recipients, not just those applying under the expanded eligibility criteria. The income test was also temporarily changed. The personal income test free area will increase from $106 to $300 per fortnight from 25 September to 31 December 2020. Income over $300 per fortnight reduces the rate by 60 cents in the dollar. In addition, the partner income test (where the partner is not receiving a pension) was expanded from 27 April 2020 to 31 December 2020. Under the changes, from 27 April to 24 September 2020, the partner income test taper rate reduces from 60 to 25 cents which increases the partner income cut-off to $3,070.80 per fortnight or $79,840.80 per annum (where personal income is below $106 per fortnight and the partner is not receiving a pension). From 25 September to 31 December 2020, the partner income test taper rate reduction will be increased from 25 to 27 cents. COVID-19 supplement From 27 April to 24 September 2020, people receiving JobSeeker Payment also receive a COVID-19 Supplement of $550 per fortnight. From 25 September to 31 December 2020, this will reduce to $250 per fortnight. It is paid automatically to eligible recipients and is a taxable payment. Example Peter recently lost his job due to the economic impacts of COVID-19. He receives JobSeeker Payment and has assessable income of $260 pf ($6,760 pa). His partner Jane works fulltime earning $2,500pf ($65,000 pa) and does not receive any Centrelink benefits. From 27 April to 24 September 2020, the partner income test taper rate reduced from 60 to 25 cents in the dollar and Peter’s JobSeeker Payment included the COVID-19 Supplement of $550 pf. The calculation of Peter’s JobSeeker Payment is as follows:

– Maximum JobSeeker Payment

– –

Less: Personal income test reduction*:

–

(256 − 106) × 50%

–

(260 − 256) × 60%

$ 518.70

(75.00) ( 2.40)

Less: Partner income test reduction: (2,500 − 996) × 25%

–

(376.00)

JobSeeker Payment entitlement

65.30

Add: COVID-19 Supplement $550

550.00

Total JobSeeker Payment entitlement

615.30

* Assumes they do not have working credits.

Mutual obligation requirements Due to COVID-19, mutual obligation requirements were temporarily suspended until 8 June 2020. In addition, the following changes were made to mutual obligation requirements to minimise face to face contact: • Jobseekers may request meetings take place via phone or via an online channel (eg Skype). • Jobseekers will be able to complete activities such as online training, creating job plans, writing a CV and preparing job applications online. • Job Plans will be adjusted to a default requirement of four job searches a month (or fewer, at provider discretion) to reflect the softening labour market conditions. • Work for the Dole and other activities delivered in group settings that cannot be delivered online will be suspended until further notice. • Job Fairs and other large events will be postponed. JobSeeker Payment recipients who cannot meet their mutual obligation requirements due to isolation or quarantine can contact Services Australia to seek a major personal crisis exemption, which can be granted without providing evidence (eg a medical certificate). Job Plan A Job Plan explains what a client needs to do to get a job or improve their employment prospects and what assistance will be offered. The Plan takes into account the person’s education, skills, experience, age, local labour market conditions and availability of training facilities. Activities that may be contained in a Job Plan include: • job search • vocational education or training • paid work experience • participation in a labour market program • participation in a Work for the Dole project • medical treatment or rehabilitation • other activities such as voluntary work. JobSeeker Payment and voluntary work From 20 September 2018, the activity testing requirements for clients aged 55 to 59 changed. From this date, voluntary work alone does not meet the activity testing requirements for the first 12 months after a client commences receiving JobSeeker Payment. Instead, these clients can meet the 30 hour activity testing requirement with a combination of approved voluntary work and paid employment, of which at least 15 hours must be paid work. After 12 months, any combination of approved voluntary and paid work can satisfy the 30 hour per fortnight activity test requirement. Partial incapacity to work A JobSeeker Payment recipient is assessed as having a partial capacity to work if they have a physical,

intellectual or psychiatric impairment and they are assessed as being unable to work, or to be trained for work of, at least 30 hours a week independently of support within the next two years. Payment eligibility and activity test requirements are based on a recipient’s work capacity within two years with intervention. Waiting periods, such as the ordinary or liquid assets waiting period, may apply to JobSeeker Payment unless temporarily exempt due to COVID-19 (¶6-720). The income maintenance period applies (¶6-730). Generally, a client does not have to meet the activity test requirements if they supply a medical certificate stating they are temporarily incapacitated. JobSeeker Payment is paid at allowance rates (¶20-470). JobSeeker Payment is subject to the assets test and the income test discussed at ¶6-520 and ¶6-540 respectively. JobSeeker Payment is taxable.

¶6-230 Partner Allowance Since 20 September 2003, there have not been any new grants of Partner Allowance. Those clients already in receipt of Partner Allowance can continue receiving the allowance until 1 January 2022. Any remaining Partner Allowance recipients will transition to Age Pension. Partner Allowance is intended to provide income for partners of income support recipients, who are unable to find work due to their limited recent workforce experience. Partner Allowance is income and assets tested as an allowance and is taxable. It is not activity tested.

Tip Partner Allowance can continue to be paid if the claimant’s spouse no longer receives their income support payment from DVA or Centrelink.

¶6-240 Parenting Payment Parents or guardians of dependent children may be eligible for Parenting Payment. This payment can be paid to partnered or sole parents. The following criteria applies: • single parents must have a child under eight to apply. Once the child turns six they are required to meet the part-time participation requirements. Once the child turns eight they must transfer to another benefit, such as JobSeeker Payment. • partnered parents must have a child under six to apply. Once the child turns six they must transfer to another benefit, such as JobSeeker Payment. Part-time participation requirements To meet the part-time participation requirements, a person needs to: • enter into a Job Plan and participate in activities • look for a part-time job of at least 30 hours a fortnight. Clients may also be able to meet participation requirements by undertaking full-time study. Due to COVID-19, mutual obligation requirements were suspended until 9 June 2020 and will then resume in a limited capacity. COVID-19 temporary measures

Due to COVID-19, the government introduced the following temporary measures for Parenting Payment: • removal of the assets test until 24 September 2020 • waiver of a number of waiting periods including the Ordinary Waiting Period, Seasonal Workers Preclusion Period and NARWP • access to an additional COVID-19 supplement of $550 per fortnight until 24 September 2020, which then reduces to $250 per fortnight until 31 December 2020. Rate of payment and means testing The rate of payment and means testing varies depending on whether the parent is a sole parent or partnered parent. However, the allowance assets test applies for both partnered and sole parents (after the temporary suspension of the asset test due to COVID-19 ends on 24 September 2020). • For partnered parents, the payment is the same as the partnered allowance rate. Where the partner does not receive a pension, the following income test applies (rates effective from 1 July 2020): – income between $106 and $256 per fortnight reduces the rate by 50 cents in the dollar – income above $256 per fortnight reduces the rate by 60 cents in the dollar – partner’s income above $996 per fortnight reduces the rate by 60 cents in the dollar. Note, the temporary changes to the income test taper rate that were applied to the JobSeeker Payment partner income test do not apply to Parenting Payment. Where the partner receives a pension, the following income test applies: – for maximum payment the couple’s combined income must be no more than $212 per fortnight – a couple’s combined income reduces the payment by 25 cents for each dollar between $212 and $512, and by 30 cents for each dollar above $512, per fortnight – for part payment, the couple’s combined income must be less than $1,991.50 per fortnight. Only one member of a couple can be eligible for Parenting Payment. • For sole parents, the payment rate is $1,340.10 per fortnight which includes the $550 per fortnight COVID-19 Supplement. Income over $192.60 (plus $24.60 for each child) per fortnight reduces the rate by 40 cents in the dollar. Pharmaceutical Allowance is also payable.

¶6-250 Austudy and Youth Allowance Austudy is paid to students aged 25 years or over who are studying an approved full-time course or a fulltime Australian Apprenticeship. Generally, secondary education courses, graduate courses (excluding most Masters and all Doctorates), undergraduate courses, associate diplomas and certain diplomas, and TAFE courses are approved for Austudy. Full-time students under age 25, or who started their course under age 25, may be eligible for Youth Allowance. Some waiting periods apply to both Youth Allowance and Austudy payments, such as the liquid assets waiting period and income maintenance period.

COVID-19 temporary measures Due to COVID-19, the government introduced the following temporary measures for Austudy and Youth Allowance: • removal of the assets test until 24 September 2020 • waiver of a number of waiting periods including the Ordinary Waiting Period, Liquid Assets Waiting Period, Seasonal Workers Preclusion Period and NARWP • access to an additional COVID-19 supplement of $550 per fortnight, which then reduces to $250 per fortnight until 31 December 2020. Student Start-up Loan From 1 January 2016, the Student Start-up Loan replaced the Student Start-up Scholarship for new recipients of Youth Allowance as a student, Austudy and ABSTUDY Living Allowance who are in higher education. The Student Start-up Loan is a voluntary loan that is repaid to the ATO when income exceeds minimum payment thresholds. The amount of the loan is $1,094 every six months. Austudy Income test Students will be assessed on their personal income and assets using two thresholds. Income over $437, up to $524, reduces Austudy by 50 cents in the dollar. Once over $524 per fortnight, income reduces Austudy by 60 cents in the dollar. For a couple, the partner income test will also apply. If the partner’s income is above the partner incomefree area, excess income reduces the student’s Austudy payment by 60 cents for every dollar over the income-free area. Where the couple have dependent children, the income-free area is $1,310.84 per fortnight. There is no parental testing as these students are considered to be independent. Student income bank Austudy students are allowed to accumulate up to $10,900 of any unused portion of their $437 per fortnight income-free area, which can be used to offset any income earned that exceeds $437. Australian apprentices can accumulate up to $1,000 of the unused fortnightly income-free area. Assets test The assets test for Austudy is the same as for any other allowance (after the temporary suspension of the asset test due to COVID-19 end on 24 September 2020). Once a person or couple’s assets are over the limits, Austudy is not paid. Youth Allowance Youth Allowance may be payable in the following circumstances: • 16 to 21 years old and looking for full-time work or undertaking approved activities • 18 to 24 years old and studying full-time • 16 to 24 years old and undertaking a full-time Australian apprenticeship. In addition, to qualify for Youth Allowance at age 16 or 17: • they must have completed Year 12 or equivalent • they must be in full-time secondary education and they need to live away from home in order to study, or

• they are considered independent for Youth Allowance. In some circumstances, Youth Allowance may be payable to clients aged 15, or older than the schoolleaving age in the state or territory in which they live, where they have been assessed as being independent. Youth Allowance means testing Youth Allowance is subject to a personal income test and a parental means test where the recipient is considered dependent. The parental means test includes both an income test and a maintenance income test. Independence Youth Allowance is subject to a personal income test and a personal assets test where the recipient is considered independent. Note, the assets test is temporarily suspended due to COVID-19 until 24 September 2020. A person will generally be considered “independent” if they are 22 or over. If they are under age 22, they may be considered independent where they: • are or have been a member of a couple that were either married or in a marriage-like relationship for 12 months • have a dependent child • have been assessed as having a partial capacity to work • have parents that cannot exercise their responsibilities as they are in prison, a psychiatric institution or similar • are unable to live at home • self-supporting through paid employment as detailed below. Self-supporting through paid employment To be considered independent, they must have worked full-time for at least 18 months within a period of two years. Full-time employment means an average of 30 hours per week throughout the 18 months. Students from inner regional, outer regional, remote and very remote areas can be assessed as independent if, since leaving secondary school, they have: • over a 14 month period, earned at least 75% of the National Training Wage Schedule since leaving secondary school, or • worked part-time (at least 15 hours each week) for at least two years since leaving secondary school. To be assessed as independent under these arrangements, they must be a full-time student and need to move away from home to study because the parents’ home is in an area considered to be inner regional, outer regional, remote or very remote. It is also a requirement that the parents earned less than $160,000 plus $10,000 for each additional child. For both dependent and independent recipients a personal income test applies. For students the test is similar to the Austudy test and for jobseekers it is similar to the Newstart Allowance income test. Student income bank Youth Allowance students are allowed to accumulate up to $10,900 of any unused portion of their $437 per fortnight income-free area, which can be used to offset any income earned that exceeds $437.

¶6-270 Widow Allowance

A woman will qualify for Widow Allowance if she: • was born before 1 July 1955 • was a member of a couple and, since turning 40, either her partner died or she separated or divorced her partner • has no recent workforce experience (in the last 12 months she has not worked for at least 20 hours per week for 13 weeks) • is not a member of a couple. From 1 July 2018, there are no new grants of Widow Allowance. Women receiving Widow Allowance immediately before 1 July 2018 can continue to receive payment. While there are no new grants of Widow Allowance from 1 July 2018, those who would otherwise be eligible and who claim JobSeeker Payment are exempted from the activity test. Widows Allowance will cease entirely from 1 January 2022. Refer to ¶20-470 for the rates of payment of Widow Allowance. The allowance income and assets tests apply. Widow Allowance is taxable.

¶6-290 Bereavement Payments A lump sum payment, known as Bereavement Payment may be payable in the event of a person’s death. To be eligible, the recipient must have: • had a partner who dies and both the partner and recipient were both receiving a pension or allowance at the date of death, or • were caring for an adult who died and they were receiving Carer Payment, and • received a pension from Centrelink or the Department of Veterans Affairs at the date of death, or • received Youth Allowance, JobSeeker Payment, Sickness Allowance, Partner Allowance, Parenting Payment or Special Benefit for at least 12 months, or • were receiving or were qualified to receive, Family Tax Benefit, Carer Payment, Carer Allowance or Double Orphan Pension for the child who died. For a couple, the lump sum payment represents the amount that would have been paid to the couple during the bereavement period (generally 14 weeks) if the deceased partner had not died minus the rate payable to the remaining partner. When a single person dies, the estate receives one extra payment of their pension or allowance. For a person receiving Carer Payment, where the person receiving care dies the carer may continue to receive Carer Payment for up to 14 weeks after the person’s death. In addition, they may receive a lump sum bereavement payment. From 20 March 2020, Bereavement Allowance is no longer be payable. However, a person qualified for Youth Allowance or Jobseeker Payment may be able to receive a one-off, higher payment if their partner dies, in addition to their regular fortnightly payments.

¶6-300 Summary of other pensions and allowances A list of other pensions, allowances and benefits which are not frequently encountered by planners is provided below. Refer to Centrelink for the rates of payment of these pensions, allowances and benefits. Double Orphan Pension An approved care organisation or individual may qualify for a Double Orphan Pension in respect of a child

under 16 years of age whose parents have both died, or where one parent is dead and the whereabouts of the other are unknown. It is also available to full-time students aged 16 to 19 who do not receive Youth Allowance. The means tests do not apply to this pension. It is usually payable in addition to FTB. The basic rate is $66.10 per fortnight as of 1 January 2020 (indexed annually on 1 January). Mobility Allowance Mobility Allowance may be payable to a person aged 16 years or older who is unable to use public transport and who: • is undertaking paid, voluntary work or vocational training for a minimum of 32 hours every four weeks • is undertaking job search activities under an agreement with employment service provider, or • is participating in Disability Employment Services, or • is receiving JobSeeker Payment, Youth Allowance or Austudy and is required to satisfy the Activity Test and needs to travel as part of work, training or job seeking. There are two rates of Mobility Allowance — the standard rate of $99.50 per fortnight and a higher rate of $139.10 per fortnight (rates as at 1 July 2020). The higher rate is payable to JobSeeker Payment, Youth Allowance, Parenting Payment or DSP recipients with a “partial capacity” to work who are working 15 or more hours per week or who are looking for work with the assistance of an employment service provider. Those who receive a funded package of support from the National Disability Insurance Scheme (NDIS) are not entitled to Mobility Allowance. Special Benefit This benefit is available to a person in severe financial hardship who is unable to qualify for other benefits. It is payable to persons who cannot earn a sufficient livelihood to support themselves or their dependants. Income and assets tests apply. Some examples of who may receive Special Benefit are: • clients who are not entitled to another payment from Centrelink because they are too young, too old, or have not lived in Australia long enough, or • persons caring for a sick or disabled person who do not qualify for Carer Payment, and • persons who have suffered a substantial change in circumstances beyond their control during the twoyear newly arrived residents waiting period.

¶6-310 Taxation of social security benefits Taxable benefits

Non-taxable benefits

Age Pension

Disability Support Pension (if under Age Pension age)

Disability Support Pension (for people of Age Pension age)

Wife Pension for DSP wives (if both spouses are under Age Pension age)

Widow B Pension

Carer Payment (if carer and person being cared for are both under Age Pension age)

Carer Payment (if carer or person being cared for is of Age Pension age)

Utilities Allowance

Wife Pension (if wife or husband of Age Pension age)

Family Tax Benefit Part A (including rent assistance, Multiple Birth Allowance)

Parenting Payment

Family Tax Benefit Part B

Bereavement Allowance

Carer Allowance

JobSeeker Payment

Youth Disability Supplement

Widow Allowance

Fares Allowance

Sickness Allowance

Double Orphan Pension

Special Benefits

Mobility Allowance

Youth Allowance

Pharmaceutical Allowance

Partner Allowance

Remote Area Allowance (offsets Zone Tax rebate)

Austudy

Rent Assistance

Education Entry Payment

Telephone Allowance Pensioner Education Supplement Abstudy supplementary benefits Pension Bonus Scheme Pension Loans Scheme Large Family Supplement Child Care Benefit Crisis Payment

¶6-320 Pension Bonus Scheme The Pension Bonus Scheme (PBS) is closed to new entrants from 20 September 2009. Existing members of the scheme will continue to accrue entitlements under the existing rules. PBS was replaced with a Work Bonus (discussed below). Pension Bonus Scheme The PBS was designed to reduce the ratio of retired people to working people by providing a monetary incentive to keep working and delay claiming the Age Pension. The PBS is a one-off bonus payment, which is paid as a tax-free lump sum. To qualify, a person who is eligible for the Age Pension (or an equivalent DVA payment) must delay claiming the Age Pension and continue working for at least 12 months. They cannot have received Age Pension at any time. Generally, clients need to register within 13 weeks of reaching Age Pension age for the bonus to be calculated from Age Pension age. The amount of the lump sum bonus is determined by the following formula: Bonus = (Base Pension Rate × (9.4% × Years Accrued)) × Years Accrued The “base pension rate” is the amount of Age Pension that the person is qualified for when they eventually claim the Age Pension. The amount of the lump sum bonus increases with the number of years that a person delays claiming the Age Pension, and is 9.4% of the annual qualifying rate of the Age Pension when the person eventually retires. This amount is multiplied by the number of years worked (up to five years). The person must undertake paid work for at least 960 hours per year. For a couple, both partners can register for the scheme, although only one partner needs to meet the work test requirements. Example Barry decides to continue working for an extra three years past Age Pension age and retire at age 69. Assuming he is entitled to $12,000 per annum of Age Pension when he retires at age 69, the amount of bonus is calculated as follows:

Bonus = ($12,000 × (9.4% × 3)) × 3 = $10,152

Tip The amount of the lump sum bonus is determined by the person’s entitlement when they claim the Age Pension. To maximise the amount of the bonus, strategies detailed in ¶6-840 (income test strategies) and ¶6-860 (assets test strategies) should be considered.

Tip Where the clients’ entitlement to the Age Pension increases within 13 weeks of claiming Age Pension, they will receive a “top up” payment of PBS.

Tip It is important to note that the bonus cannot accrue during the five years after an excess gift (ie over the allowable limits) has been made.

PBS or Work Bonus? In some cases, clients may be better off claiming a part Age Pension rather than receiving the PBS. Advisers need to compare the rate of Age Pension the client would receive (taking into account the work bonus, if applicable) with the estimated amount of PBS payable.

¶6-340 Rent Assistance Rent Assistance is available for social security recipients who pay private rent in excess of certain prescribed amounts. Rent Assistance is generally not payable to aged care residents or people who pay government rent. Certain age restrictions apply to recipients of Disability Support Pension and Youth Allowance. Special rules also apply to single sharers of rented accommodation and boarders. Clients who are eligible for rent assistance and receive more than the base rate of Family Tax Benefit Part A, receive rent assistance as part of their FTB payment. Rent Assistance is paid as a supplement to a person’s pension or allowance payment. To qualify for Rent Assistance a person must be paying more than the threshold amounts for: • rent (other than for public housing) • service and maintenance fees for a retirement village (if assessed as a non-homeowner. See ¶6-560 Pensions, the assets test and the family home) • lodging — where a person pays an amount for board and the lodging portion cannot be identified, twothirds is assumed to be for lodging • caravan site fees where the caravan is the person’s principal home • mooring fees for a boat where the boat is the person’s principal home.

Rent Assistance is not taxable.

¶6-350 Family Assistance payments The main benefits provided for families are Family Tax Benefit (FTB) Part A, Family Tax Benefit Part B, Child Care Subsidy, Parental Leave Pay, Dad and Partner Pay and the Newborn Upfront Payment and Supplement. Payments can be made fortnightly or annually depending on the payment. Income and assets tests For all payments, an estimate of income for the current financial year is required (with the exception of people on income support). The income test does not apply if the recipient or their partner receives an income support payment such as a pension, benefit, or allowance or a Department of Veterans’ Affairs service pension. There is no assets test for these payments. Definition of income Family adjusted taxable income includes: • taxable income • reportable fringe benefits • reportable superannuation contributions • total net investment loss • any target foreign income • any non-taxable pensions or benefits. Note: Any child support paid reduces ATI. Reconciliation At the end of each financial year, the client’s estimated income is compared to their actual income. If the client has overestimated income, a top-up payment is made. If income is underestimated, benefits will be required to be repaid. Newborn Upfront Payment and Supplement Families eligible for Family Tax Benefit Part A who are not accessing Parental Leave Pay, may receive the Newborn Supplement as an increase to the Family Tax Benefit Part A rate for a period of up to 13 weeks to help with the upfront costs of a newborn child. The Newborn Upfront Payment is a lump sum payment of $570 paid in addition to FTB Part A. The extra amount of Newborn Supplement and Newborn Upfront Payment for eligible families totals up to $2,279.89 for the first child (and each child in a multiple birth) and up to $1,140.57 for subsequent children. Paid parental leave scheme The paid parental leave scheme consists of Parental Leave Pay and Dad and Partner Pay. Both payments may be paid for the same child. Parental Leave Pay is payable up to 18 weeks and Dad and Partner Pay is payable up to two weeks at $753.90 per week. For Parental Leave Pay, eligible persons must satisfy all of the following conditions: • primary carer (usually the mother) of a newborn or adopted child from 1 July 2011 • meet the Paid Parental Leave scheme work test before the birth or adoption occurs

• have received an individual adjusted taxable income of $150 000 or less in the financial year before the date of birth or adoption or date of claim, whichever is earlier, and • are on leave or not working, from when they became the child’s primary carer until the end of the Paid Parental Leave period. Recipients must also pass both of the following work test conditions: • worked for at least 10 of the 13 months before the birth or adoption of the child, and • worked for at least 330 hours in that 10-month period (just over one day a week), with no more than an eight-week gap between any two consecutive working days. Changes to Parental Leave Pay For babies born or adopted before 1 July 2020, Parental Leave Pay is payable for a continuous block of up to 18 weeks. However, under new rules which apply to babies born or adopted on or after 1 July 2020, Parental Leave Pay may include both: • a continuous Paid Parental Leave period of up to 12 weeks • 30 Flexible Paid Parental Leave days. Flexible Paid Parental Leave days must be taken before the child turns two. FTB Part A and Part B are discussed at ¶13-710 to ¶13-725. The child care subsidy is discussed at ¶13-730.

¶6-360 Other Centrelink benefits Health Care Card The Health Care Card is issued to: • people on low incomes (see low income test) • recipients of JobSeeker Payment, Youth Allowance, Partner Allowance, Widow Allowance, Family Tax Benefit Part A maximum rate as fortnightly payments, Parenting Payment (Partnered), Sickness Allowance or Special Benefit • children whose parents qualify for Carer Allowance. Low income test The income test applies to average weekly gross income for the eight weeks immediately prior to applying for the card. Income is based on Centrelink’s standard assessment of income as well as including any social security pensions or benefits. The definition of income also includes deemed income from accountbased pensions. The Health Care Card is not asset tested. The table below shows the income limits to qualify for the health card known as the 100% limit. To retain the health card after grant, the client’s income must be below the 125% limit over any eight-week period. Thresholds are effective from 1 July 2020. 100% limit per week 125% limit per week Single (no children)

$571.00

$713.75

Couple, combined (no children)

$985.00

$1,231.25

Single, one dependent child

$985.00

$1,231.25

Add for each additional dependent child

$34.00

$42.50

The card is also available to people who have received JobSeeker Payment, Partner Allowance, Widow Allowance, Special Benefit, Parenting Payment (Partnered) or Youth Allowance payments for over 12 months and whose payment was cancelled due to an increase in income from employment. A person in this category is entitled to the card for six months after commencement of such employment. The Health Care Card entitles recipients to concessional pharmaceutical prescriptions and a limited number of extra concessions from state and local government authorities. Commonwealth Seniors Health Card (CSHC) The Commonwealth Seniors Health Card provides concessional rates on pharmaceutical benefits. Holders of the card may also receive a discount or concession on: • bulk billed doctor appointments, at the discretion of the doctor • cheaper out of hospital medical expenses through the Medicare Safety Net • in some instances, extra health, household, transport, education, and recreation concessions that are offered by state or territory and local governments and private businesses — these providers offer concessions at their own discretion, and the availability of these concessions may vary between states and territories. In addition, CSHC holders may be eligible for the energy supplement. See more information below. Eligibility To qualify for the CSHC, a person must: • be of pension age • not be receiving an Age or DVA Pension • be in Australia and be an Australian resident • satisfy the Seniors Health Card income test: – $55,802 for singles – $89,290 for couples – $111,616 combined for couples separated by illness. Income thresholds are effective from 20 September 2019 to 19 September 2020. Note: A non-income tested CSHC was issued to those who had their pension cancelled on 1 January 2017 due to the assets test changes. Seniors Health Card income test CSHC income test includes: • adjusted taxable income, and • deeming on account-based pensions. Adjusted taxable income includes: • taxable income • employer provided benefits • reportable superannuation contributions • total net investment loss

• foreign income • employer provided benefits. Deeming of account-based pensions Since 1 January 2015, account-based pensions are subject to deeming and included in the CSHC income test unless they are grandfathered. Grandfathering applies to account-based pensions where: • the person held a CSHC immediately before 1 January 2015 and is continuously in receipt of the CSHC, and • commenced the account-based pension before 1 January 2015 and retains the same account-based pension.

⊠ Trap Take care rolling over an account-based pension that is grandfathered. If the client rolls over to a new account-based pension provider after 1 January 2015 the pension will be deemed.

Example Jill is single and the holder of a CSHC since 2012. Jill’s adjusted taxable income is $48,000. She also has an account-based pension purchased in 2010 that is not included in the income test as it is grandfathered. However, Jill decides to rollover her account-based pension to a new provider in March 2020. As a result, deemed income of $10,000 from the account-based pension is included in the CSHC income test and causes Jill to exceed the threshold of $55,802.

⊠ Trap Where the CSHC holders’ partner was under pension age at 1 January 2015, any account-based pensions in their name do not qualify for grandfathering as the partner was not in receipt of a CSHC at 1 January 2015.

Example Harry is 70 and Maureen is 65 at 1 January 2020. Harry is the holder of a CSHC. Both Harry and Maureen have account-based pensions that commenced before 1 January 2015. Harry’s account-based pension is grandfathered and not included in the CSHC income test as he was the holder of a CSHC at 1 January 2015. However, Maureen’s account-based pension is not grandfathered as she was not the holder of a CSHC at 1 January 2015. This means that deemed income from her account-based pension is included in the CSHC income test as it includes the couples combined income. Unfortunately, Harry is not entitled to the CSHC as their combined income exceeds $89,290. If Harry reapplies for the CSHC in the future, his account-based pension will no longer be grandfathered as he does not meet the requirement of being continuously in receipt of the CSHC.

What about reversionary account-based pensions? If a client has an account-based pension that is grandfathered for CSHC income test purposes, and the account-based pension is reversionary, the account-based pension will retain its grandfathered status when it reverts on death to the beneficiary as long as the beneficiary is in receipt of a CSHC at the time of reversion.

Will the account-based pension be grandfathered if they later apply for Age Pension? No. If they have an account-based pension that is grandfathered for CSHC purposes and they later apply for the Age Pension, the account-based pension will not be grandfathered for the Age Pension income test. For an account-based pension to qualify for grandfathering for income support payment purposes the client must have been in receipt of an income support payment before 1 January 2015. See deeming of account-based pensions at ¶6-840 for more information. Energy supplement The energy supplement is payable quarterly to holders of the CSHC who were granted the card before 20 March 2017. Those who were granted the CSHC on or after 20 March 2017 are not eligible for the energy supplement. Grandfathering rules Where a client received an income support payment on 19 September 2016 and within six weeks of their income support payment stopping they claimed a CSHC, they will remain eligible for the energy supplement beyond 20 March 2017. For pensioners who lost entitlement to the Age Pension on 1 January 2017 due to the assets test changes, they were automatically issued a non-income tested CSHC. These clients remain eligible for the energy supplement beyond 20 March 2017. Pensioner Concession Card The Pensioner Concession Card is issued to people who are in receipt of: • Age Pension • Disability Support Pension • Parenting Payment (single) • Carer Payment • Bereavement Allowance • JobSeeker Payment or Youth Allowance (job seeker) if the person is single, caring for a dependent child and looking for work. It is also available for people who are aged over 60 and have been receiving one of the following payments for more than nine months — JobSeeker Payment, Sickness Allowance, Widow Allowance, Partner Allowance, Parenting Payment (partnered) or Special Benefit. Once in receipt of a Pensioner Concession Card, people who re-enter the workforce retain their card for six months. Generally, they must have been in receipt of an income support payment for more than nine months prior to returning to work. Disability Support Pension recipients who no longer receive payment due to full-time employment retain the Pensioner Concession Card for 12 months. The main concession under the Pensioner Concession Card is access to reduced cost pharmaceuticals under the Pharmaceuticals Benefits Scheme. They may also be entitled to various concessions from the Australian Government including: • bulk billing for doctor’s appointments • more refunds for medical expenses through the Medicare Safety Net • assistance with hearing services through the Office of Hearing Services • discounted mail redirection through Australia Post.

They may also be entitled to various concessions from state and territory governments and local councils including: • reductions on property and water rates • reductions on energy bills • a telephone allowance • reduced fares on public transport • reductions on motor vehicle registration • free rail journeys. Pensioner Concession Card reinstated Pensioners who lost their entitlement to the Pensioner Concession Card as a result of the assets test changes from 1 January 2017, had their card reinstated from 9 October 2017. Telephone allowance There are two rates of telephone allowance — basic rate and higher rate. The basic rate of $30.20 per quarter (as at 20 September 2019, indexed annually on 20 September) is payable to people in receipt of: • Disability Support Pension under 21 with no dependent children • Parenting Payment (single) • Parenting Payment (partnered) if claimed on or after 1 July 2006 and assessed as having a partial capacity to work due to a disability • JobSeeker Payment or Sickness Allowance over 60 and in receipt of an income support payment continuously for nine months • Partner Allowance, Widow Allowance, Special Benefit or Parenting Payment (partnered) and over 60 but under Age Pension age and in receipt of an income support payment continuously for nine months • JobSeeker Payment or Youth Allowance with a partial capacity to work as assessed by a Job Capacity Assessor • Partner Allowance or Parenting Payment (partnered) where the partner is over 60 and receives JobSeeker Payment or Sickness Allowance and has received income support payments continuously for nine months • JobSeeker Payment or Youth Allowance and single principal carer of a dependent child. The higher rate of $44.60 per quarter is payable to people in receipt of: • Disability Support Pension under age 21 with no dependent children, and • have a home internet service connected in your or your partner’s name.

DEPARTMENT OF VETERANS’ AFFAIRS BENEFITS ¶6-400 Overview of the Department of Veterans’ Affairs The Department of Veterans’ Affairs (DVA) provides care, compensation and commemoration for

Australia’s veterans. DVA pays two main types of pensions — Age Service Pension and compensation pensions. Of the compensation pensions, the most common types are Disability Pension and War Widow/er Pension. The following sections give an overview of these payments and their means testing and tax treatment.

¶6-420 Service Pension As the name implies, to qualify for a Service Pension an Australian veteran must have qualifying service. Some Commonwealth and Allied veterans who served with Australian forces may also be eligible. Veterans should check with DVA as to whether they have qualifying service but, generally, they need to have served in the armed forces in areas where they were in danger from hostile forces. Age Service Pension Age Service Pension is similar to Age Pension paid by Centrelink. It is income and assets tested in the same manner, with similar payment rates, income-free areas and asset limits. Blind veterans are not income or assets tested. As with Age Pension, the Age Service Pension is taxable and pensioners can claim the Senior and Pensioner Tax Offset. Age Service Pension is paid at an earlier age than Centrelink Age Pension. For both males and females, the Age Service Pension age is 60. Note, the qualifying age for females born prior to 1 January 1954 was younger. Invalidity Service Pension This is a service pension paid to a veteran who has qualifying service but cannot work due to an incapacity and who has not reached the Age Service Pension age. The incapacity does not need to be service related. This payment is income and assets tested. It is not taxable where the person is under Age Pension age. If incapacitated due to war or defence service then a Disability Pension may be payable (¶6-440). Partner Service Pension A Partner Service Pension can be paid to: • the partner of a veteran with qualifying service • former partner of a veteran with qualifying service • widow or widower of a veteran who had qualifying service. Qualifying age There is no age requirement where the partner has a dependent child or the veteran receives T & PI (total and permanent incapacity) special rate disability pension. There is an age requirement of 50 or over where the veteran is receiving an above general rate disability pension. Where the partner does not fit into the above criteria, the age requirement is age 60 for males and females.

¶6-440 Disability Pension DVA pays different types of Disability Pension as compensation to veterans who have an injury or disease due to war or defence service. Of these, the most common types are outlined below. General rate The level of pension paid depends on the level of disability. Each veteran is given a rating of disability and

the maximum rate is paid where the rating is 100%. The ratings then drop by 10% increments for less disabled veterans. As the rating drops, the payment also reduces by increments of 10%. The minimum rating is 10%. In addition to this payment, veterans who have suffered blindness or amputation may also receive a specific disability adjustment (determined by DVA). Special rate (also known as T&PI) Special rate or totally and permanently incapacitated rate (T&PI) is paid to veterans who are severely incapacitated (unable to undertake more than eight hours of paid employment per week). Special rate can also be paid for temporary incapacity. The T&PI is $1,451.80 per fortnight (indexed 20 March and 20 September). Disability Pensions are not income or assets tested and are not taxable.

¶6-460 War Widow/er Pension If a veteran dies due to war-caused disease or injury, their widow/er may be entitled to a pension from DVA. This is known commonly as War Widow/er Pension; however, it can also be paid to men whose wives served in war or the defence forces. In most cases the War Widow/er Pension must be claimed by the widow/er following the death of their veteran partner. However, in some cases it will be paid automatically, ie: • where the veteran received, or was eligible to receive, a T&PI pension • where the veteran was an Australian prisoner of war, or • where the veteran qualified to receive a specific disability amount (determined under the Veterans’ Entitlements Act 1986 s 27). This pension is not taxable, nor income and assets tested, and may be paid to a legally married spouse or de facto. The rate from 20 March 2019 to 19 September 2019 is $960.40 per fortnight. A person in receipt of this pension may also be eligible for an Income Support Supplement. Income Support Supplement Income Support Supplement (ISS) is an additional benefit paid to war widow/er(s) with limited income and assets. The maximum supplement can amount to an extra $284.20 per fortnight (indexed 20 March and 20 September) in addition to receiving the War Widow/er Pension. Eligibility for the ISS applies to all war widow/er(s) and War Widow/er Pension recipients, regardless of age. Previously war widow/er(s) were only eligible when they reached the qualifying age for ISS if they did not have children. This supplement is income and assets tested and the War Widow/er Pension payment is included in assessable income.

¶6-480 Concession cards DVA offers two types of Repatriation Health Cards — the Gold Card and the White Card. Gold Card The Gold Card entitles the holder to health care for all types of ailments and conditions, whether warcaused or not. There is a Pharmaceutical Benefits Scheme and dental care. Veterans are also entitled to hearing aids at no cost as well as community nursing care. Veterans holding this card and their dependants are exempt from paying Medicare levy. All veterans with qualifying service who are over 70 years of age qualify. Other eligibility criteria include: • being an ex-prisoner of war • receiving the general rate Disability Pension with a 100% rating, or

• being an Age Service Pension veteran who is blind in both eyes. This list is not exhaustive and veterans should check with DVA. White Card The White Card is for specific conditions only that relate to war service. White Card holders are also entitled to the Pharmaceutical Benefits Scheme and full dental treatment where it relates to the specific conditions.

MEANS TESTS ¶6-500 Means testing social security Social security pensions, allowances and benefits are subject to means tests to ensure that benefits are only paid to people who are in need of them. The means tests each contain a threshold level and a cut-off level. • If the relevant amount of income or assets does not exceed the threshold level, the amount of payment to which a person is entitled is not affected. • If the person’s income or assets exceed the threshold level, the person’s entitlement starts to decrease. That is, the more the income or assets exceed the respective threshold amounts, the less the person’s entitlement. • If the person’s income or assets exceed the cut-off level, the person is not entitled to payment. Pensions are subject to an income test and an assets test. Where a person’s entitlement is subject to both the income and the assets tests, the test that results in the lower rate of payment is the one applied. In relation to allowances, they are also subject to both an income and assets test. However, the assets test does not have a threshold level where the allowance starts to decrease as with pensions. Rather, it has a cut-off point where no allowance is payable once the cut-off point is reached. The following sections outline the operation of the assets test and the income test. Particular attention is given to the special rules which apply to the assessment of certain investments (¶6-580) and income streams (¶6-640) under the income and assets tests. Planners must ensure that their clients’ investment affairs are structured so that they maximise overall wealth while also maximising entitlements to social security payments.

¶6-520 Assets test Under the assets test, the rate of pension or allowance is reduced where the recipient (or the recipient’s partner) holds assets over a specified limit. Allowances For allowance recipients, once assets exceed the limits set out at ¶20-550 and ¶20-560, there is no entitlement to any benefits. Therefore it is very important to ensure that a client’s assets are below the limit if they are to receive any Centrelink benefits. Note, due to the economic impacts of COVID-19, the government has temporarily removed the assets test for JobSeeker Payment, Youth Allowance, Parenting Payment and Austudy from 25 March to 24 September 2020. Pensions Under the assets test for pensioners, where a person (or couple) who is receiving payment owns assessable assets with a value in excess of the limits set out at ¶20-550 and ¶20-560, the amount of pension payable will be reduced. A person’s (or couple’s) asset value limit depends on the person’s family and home ownership situation. The asset value limits are indexed annually on 1 July.

Assessment of assets It is necessary to determine which assets are taken into consideration under the assets test. The term “asset” is defined to mean property, including property outside Australia. Basically, all of a person’s (or couple’s) assets, such as money, goods, real estate, personal property and debts owing to the person, are included for the assets test. The only assets which are not taken into account are those which are specifically exempt. Principal home The most important asset which is exempt is the “principal home”. The principal home is the house or unit, which is the residence of the person as well as up to two hectares of surrounding land and the permanent fixtures which are attached, such as carpets, dishwashers, garages and swimming pools. In some circumstances, the main residence exemption can be extended to include all land on the same title as a person’s principal residence (see ¶6-560 for more information). Other exempt assets include: • life interest not created by the person or person’s partner • investment in a superannuation fund, approved deposit fund (ADF), deferred annuity (DA) or retirement savings account (RSA) (exemption ceases when the client reaches Age Pension age) • contingent, remainder or reversionary interest • interest in an estate until it is received or able to be received • medal or decoration for valour • funeral bonds that cost up to $13,500 (as at 1 July 2020). When determining the cost of a funeral bond, it is the original sum paid plus any additional payments or instalments, but importantly it does not include interest • aids for disabled persons • certain insurance or compensation payments • native title rights and interests • assets test exempt portion of income streams (¶6-640) • lump sum accommodation bonds/payments paid to residential aged care facilities. Valuation of assets The general rule under the assets test is that the value of an asset is the net market value, which is the amount an asset could be sold for, less any debts secured against the asset. There are, however, special rules which apply to the assessment of certain investments and income streams. In some cases unsecured loans used to purchase an assessable asset can also reduce the assessable value of the asset. These rules are discussed at ¶6-580 and ¶6-640 respectively.

¶6-540 Income test Under the income test, the rate of payment of a pension or allowance is reduced where the person (or the person’s partner) receives, or is deemed to receive, income above a specified rate (¶6-600). That is, a person is permitted to receive a certain amount of income before the person’s entitlement to payment is affected. This is called the “income-free area”. There are different income-free areas depending on the person’s family situation and these are set out at

¶20-530. Pensions The lower income test threshold is indexed on 1 July each year. Where a pensioner has income exceeding the lower income test threshold, the pension is reduced by 50 cents in the dollar for a single pensioner and by 25 cents in the dollar for each member of a couple. From 20 September 2009, the income test taper increased from 40 to 50 cents in the dollar for a single pensioner and from 20 to 25 cents in the dollar for each member of a couple, for income over the relevant income-free threshold. Existing pensioners adversely affected by the income test changes receive a transitional rate, allowing them to keep existing entitlements, maintained in real terms. They will continue to receive these existing entitlements until they are better off under the new pension rules.

Tip If we assume that a pensioner’s only assets are financial investments subject to deeming, then the maximum amount they could hold in financial investments and still receive the maximum pension under the income test is: • single — $252,800 • couple — $443,377.

Example Dan is a single age pensioner with $252,800 in financial investments subject to deeming. Deemed income is: $53,000 × 0.25% = $132.50 $199,800 × 2.25% = $4,495.50 Total deemed income pa $132.50 + $4,495.50 = $4,628.00 Total deemed income pf ($4,628.00 / 26) = $178.00. Dan will receive the maximum Age Pension as his assessable income does not exceed the lower income threshold. For more information on deemed income see ¶6-580.

Work Bonus The Work Bonus encourages paid employment by reducing the amount of employment income that is counted under the income test. From 1 July 2019, the income from self-employment that includes gainful work is also included. The Work Bonus discounts employment income by a flat $300 per fortnight (¶6-140). In addition, any unused work bonus can accrue up to $7,800. The accrued bonus can then be used to reduce employment income that exceeds $300 per fortnight. The Work Bonus applies to Centrelink pensioners of Age Pension age or DVA pensioners of service pension age receiving the Service Pension or Income Support Supplement. Allowances The allowance income test is as per the table below. Fortnightly Income

Income Test Reduction

$0–$106

—

$106–$256

50 cents per dollar

Over $256

60 cents per dollar

Excess Partner Income

60 cents per dollar

Temporary changes due to COVID-19 Note, due to the economic impacts of COVID-19, the government has proposed a temporary change to the personal income test from 25 September to 31 December 2020 for JobSeeker Payment and Youth Allowance (Other). The income free area will increase from $106 for JobSeeker Payment and $143 for Youth Allowance (Other) to $300 per fortnight, and income over this threshold will reduce payment by 60 cents in the dollar. The partner income test for JobSeeker Payment will also change. From 27 April 2020 to 24 September 2020, the partner income test taper rate reduced from 60 cents per dollar to 25 cents per dollar. The government also announced its intention to extend this partner income test taper rate reduction and increase the taper rate from 25 to 27 cents from 25 September to 31 December 2020. Example Rodney is a single JobSeeker Payment recipient. Rodney has assessable income of $302 a fortnight. His entitlement is calculated (prior to 25 September 2020) as follows:

$ Maximum amount of allowance

574.50

Less: lower range reduction (50% × ($256−$106))

(75.00)

 upper range reduction (60% × ($302−$256))

(27.60)

Amount of entitlement

471.90

Add: COVID-19 Supplement (payable between 27 April to 24 September 2020)

550.00

Total entitlement

1,021.90

Income is defined broadly and includes all types of income except for items that are specifically exempt under the income test. Exempt items of income include: • returns on investments in accumulation phase of superannuation until the person reaches Age Pension age • home equity conversion loans • emergency relief • payments in respect of a dependent child • payment of an allowance by an employer for expenses • certain specified insurance payments • exempt funeral investments • rent subsidy • medical benefits

• payments to members of the Reserve Forces • payments from family members • certain other exclusions. There are special rules for assessing income from investments and income streams (see ¶6-580 and ¶6640 respectively). Working credits Working credits are available for people below Age Pension age, with the exception of students (who may be eligible for student income bank) and people in receipt of Special Benefit. Working credits are accrued at times when the client has little or no income and then used to reduce the amount of later employment earnings that are counted under the income test. The working credit accrues to a maximum of $1,000. Accrual occurs where the client’s fortnightly income is less than $48.

HOUSING IN RETIREMENT ¶6-560 Pensions, the assets test and the family home This is a brief overview of the effect of owning a family home on various pension and other entitlements. It is beyond the scope of this chapter to examine the social security system or the assets test in detail. When valuing property for assets test purposes, the following are not taken into account: • for an individual — the value of their interest in the principal home where there is reasonable security of tenure • for a couple — the value of their interest in one residence only which is the principal home of either or both of them where there is reasonable security of tenure. The “principal home” exemption under the assets test applies to: • a house or unit which is the residence • permanent fixtures in the home • any garage, shed, tennis court, swimming pool, etc • where the home is a flat or home unit — garages or storerooms that are used primarily for private or domestic purposes in association with the flat or home unit • curtilage — generally two hectares on the same title as the principal home is exempt from assessment. In some cases, land exceeding two hectares may be exempt where the extended land use test applies. Extended land use test Under the extended land use test, all land on the same title as the principal residence can be exempted provided the following eligibility criteria are met. The person must: • be of Age Pension age and qualify for the Age Pension, Carer Payment or Department of Veterans’ Affairs Service Pension • have a long-term (20-year) continuous attachment to the land and their principal home, and • make effective use of productive land to generate an income, given their capacity. A range of factors are considered when determining whether a client is making effective use of the land including the location, the client’s health and family situation, the current and potential use of the land,

legal and environmental issues and whether titles have been amalgamated to gain an advantage. Effective use of the land is not limited to the client (or their partner) working the land to its potential, and effective use of the land may be satisfied with a close family member working the land, where the land is leased and in certain circumstances where the land is not being worked if it has limited potential to generate an income. Self-contained living areas Where a person’s home includes a self-contained living area (eg “granny flat”) then: • if that area is either vacant or let to a member of the immediate family, a blood relative, a relative by marriage or an adopted child, it is treated as part of the person’s principal residence and disregarded for assets test purposes • if that area is let to a person who is not a family member (as specified above), its value is not disregarded for assets test purposes. Homeowners or non-homeowners? Whether a person is considered a homeowner or non-homeowner determines the applicable assets test thresholds. A reference to a right or interest of a person in relation to a principal home does not include a right or interest that does not give reasonable security of tenure. The following table shows which persons will be treated as home owners and which persons will be treated as non-home owners. Persons treated as home owners

Persons not treated as home owners

– persons residing in a home owned (including partly) by themselves or their partner

– persons who pay rent or board and lodgings for accommodation

– persons who have a life interest in the home in which they live

– persons residing in a retirement village or granny flat who have not paid or donated money to secure accommodation (or paid an amount below the extra allowable amount)

– persons who have paid or donated money to secure a granny flat or retirement village (above the extra allowable amount)

– persons who own a home but have been temporarily absent for more than 12 months

– persons who own a home but are temporarily absent from it (during first 12 months of absence)

– persons who live in a boat or caravan they do not own

– persons who live in a boat or caravan they own

– other persons who do not have legal title to the accommodation in which they reside

– other persons who have legal title to the accommodation in which they reside For clients who have entered a residential aged care facility, the rules are quite complex when determining whether they are a homeowner or non-homeowner. See ¶17-000 Retirement living and aged care for more information.

ASSESSMENT OF INVESTMENTS ¶6-580 Assessment rules There are several assessment rules to which planners should pay particular attention, including:

• deeming provisions concerning financial assets — ¶6-600 • treatment of superannuation — ¶6-610 • treatment of private trusts and companies — ¶6-620 • treatment of income streams — ¶6-640 • treatment of property investments — ¶6-660 • treatment of reverse mortgages — ¶6-660.

¶6-600 Financial assets and deeming The deeming provisions provide a relatively simple and predictable manner of assessing income from financial assets. The system also provides a strong incentive for astute investment by not counting any returns above the deeming rate as income. It is also a relatively neutral system as it treats all financial investments in the same way. Under the provisions, predetermined interest rates are applied against the investments held by a person (or couple) for the purpose of calculating income under the income test. As at 1 July 2020, for single people receiving either a pension or allowance, a deeming rate of 0.25% applies to the first $53,000 of financial assets and any amount over that is deemed to earn income at 2.25% per annum. For couples, where at least one member is receiving a pension, the first $88,000 (combined) is deemed to earn income at 0.25% and any amount over that is deemed to earn 2.25%. Where neither member is receiving a pension, the first $44,000 for each member is deemed to earn income at 0.25% with any amount over that deemed to earn income at 2.25%. The deeming rules apply to the total value of a person’s financial assets, regardless of the nature of the asset or when it was purchased. Financial assets include: • cash, bank, building society and credit union accounts • term deposits, cheque accounts and friendly society bonds • managed investments • investments in superannuation where the owner is over Age Pension or Age Service Pension age • listed shares and securities and shares in unlisted public companies • loans, debentures and bonds • gifted assets above the allowable gifting value of $10,000 per financial year or $30,000 over a fiveyear period (¶6-860) • gold and other bullion • short-term (five years or less) income streams • certain account-based income streams from 1 January 2015. See ¶6-640 for more information. Financial assets do NOT include: • the home or its contents • a lump sum accommodation bond/payment for residential aged care

• cars, boats and caravans • coin or stamp collections • investments in superannuation funds, ADFs and deferred annuities where the owner is under Age Pension or Age Service Pension age • standard life insurance policies • holiday houses, farms or other real estate • income stream products. However from 1 January 2015, account-based pensions may be subject to deeming. Special rules apply to income stream products and these are discussed at ¶6-640.

¶6-610 Superannuation Superannuation is exempt from the social security income and assets tests until Age Pension age. Once a person reaches Age Pension age, superannuation is counted as a financial asset and is subject to deeming. This measure offers great financial planning opportunities to structure finances to increase entitlements. For example, where one member of a couple is under Age Pension age, funds can be contributed into superannuation in their name and become exempt from both the assets and income test.

Tip Clients may have already purchased an income stream such as an account-based pension with their superannuation monies. Income streams (other than assets test exempt income streams — see ¶6640) are assessable under the assets test. In addition, they may produce assessable income such as certain account-based pensions subject to deeming from 1 January 2015. A strategy to reduce assessable assets and income is to roll their account-based pension back into accumulation phase to take advantage of the superannuation exemption until Age Pension age. Alternatively, consideration should be given to commuting the pension and contributing the funds into a partners accumulation account if they are under Age Pension age. Note that taxation implications would also need to be taken into account when considering this strategy.

Note Withdrawals from superannuation are not assessable under the Centrelink income or assets test and there is no gifting assessed when money is transferred between members of a couple.

Downsizer contributions From 1 July 2018, clients aged 65 and over are able to make super contributions of up to $300,000 per person from selling their main residence (¶4-222). A key benefit of downsizer contributions is the ability to invest home sale proceeds in the concessionally taxed super environment when over age 65 without having to meet the work test or contribution caps. However it is important to note that the legislation for downsizer contributions does not specify any related changes to the social security or aged care assessment laws. Therefore the social security and aged care impact of a downsizer contribution needs to be considered.

For social security purposes the principal home (which includes certain adjacent land) is an exempt asset, regardless of its value.

Tip If a client, aged 65 or over, uses some of the proceeds from the sale of their main residence to make a downsizer contribution to super, that amount is effectively converted from being asset test exempt (when it was invested in the family home) to being asset tested as a superannuation accumulation interest.

If the client is of Age Pension age, super in the accumulation phase is generally assessed as a financial investment for the assets test and is subject to deeming for the income test. If the downsizer contributions are subsequently invested in an account-based income stream, that income stream is similarly assessed for the assets test and subject to deeming for the income test. So, depending on the client’s personal situation, having more money in super, rather than a main residence may reduce their Centrelink benefits.

¶6-620 Private trusts and companies A private trust, or company recognised as a “designated” private trust or company, is attributed to the person(s) who either control or have contributed the assets. Attributed assets are assessed as follows: (1) under the assets test, the net asset value of the attributed assets is assessable. (2) under the income test, the gross value of the attributed income is assessable. If the company or trust is running a business, the amount of attributed income will be reduced by the amount of any business expenses that are considered under the Income Tax Assessment Act 1997 (ITAA97) to be allowable deductions. Some expenses are not allowable deductions such as prior year losses and building depreciation. To determine whether an entity is a designated trust or company, two tests are applied. Control test Under this test, the actual controller of a structure is considered to be the owner of the assets. The actual controller may not always be a director or trustee of the entity. The control test allows Centrelink and the DVA to consider the relationship between the director or trustee and any person who may influence the controller in their duties (ie an associate), whether directly or via another entity. For trusts, the controller is generally the appointor of the trust as they may have the power to dismiss or appoint trustees or veto trustee decisions. For companies, the controller is the person who has voting powers or governing director powers. This reflects the power they have to retain profits within the structure or reduce or eliminate profits by paying themselves higher directors fees. It is important to note that the definition of “associate” for a social security recipient is not confined to family members. It could include, for example, a business partner. Source test The source test is designed to identify the ultimate source of assets that are held in the trust or company. The source of an asset can be traced back through several intermediaries where appropriate.

In applying this test the government has recognised that, generally, when a person transfers assets into an interposed structure, the assets will usually be used to benefit that person or that person’s family. If a person claims that the transfer of assets into the trust or company was a gift, the assets will only be exempt if the person is not deemed to be the actual controller of the trust or company. In this case the gifting provisions would apply. For the purposes of the source test only, any assets transferred into a designated company or trust: • before 7.30 pm EST on 9 May 2000, or • after 7.30 pm EST on 9 May 2000, if an arm’s length amount was paid to the source by the company or trust in exchange for those assets, will be ignored. Testamentary trusts If a testamentary trust becomes active due to a death on or before 31 March 2001, the trust’s assets and income are generally attributed to the formal controller under the control test. However, if the trust is being administered for the benefit of the surviving spouse and the surviving spouse is exercising informal control, attribution will be to the surviving spouse under the control test. If the trust becomes active due to a death after 31 March 2001, the assets and income of the trust are attributed to the surviving spouse if: • the surviving spouse directly controls the trust, irrespective of whether they are a beneficiary or not, as it is assumed that if the surviving spouse directly controls the trust, he or she could put themselves in a position to receive a benefit, or • an associate has control and the surviving spouse is a potential beneficiary; in this case, Centrelink and the DVA will assume that the surviving spouse will enjoy the benefits of the trust. Special disability trusts A special disability trust is a trust established for the future care and accommodation needs of a person with a severe disability. The general approach is that the trust can pay for any care, accommodation, medical costs and other needs of the beneficiary during their lifetime. Special disability trusts can be an effective structure when providing for a disabled beneficiary as they provide taxation and social security concessions for both the beneficiary and donors gifting to the trust. A special disability trust receives the following concessions: • amounts contributed to the trust up to $500,000 will not be assessed as gifting by the contributors if they are immediate family members of the principal beneficiary and at or over Age Pension age • the assets of the trust up to $694,000 (as at 1 July 2020) will not be assessed as an asset against the principal beneficiary and income distributions will not be counted under the income test. To qualify as a special disability trust it must meet specific legislative requirements, for example, the trust deed must include the compulsory clauses of a “model trust deed”. To qualify for concessions, the special disability trust must have one beneficiary: • whose level of impairment would qualify the person for Disability Support Pension or who is already receiving a DVA invalidity or ISS, and • is unable to work more than seven hours per week, and • if the person had a carer, that carer would qualify for carer payment or allowance, or • who is living in an institution, hostel or group home in which care is provided for people with

disabilities and for which funding is provided under an agreement between the Commonwealth, state and territories. Allowable expenditure A special disability trust’s main purpose is to meet the care and accommodation needs of the principal beneficiary. The trust is allowed to pay for: • costs of care such as aids and vehicle modifications • accommodation such as modifications to the beneficiary’s residence • medical expenses including private health fund membership and dental care, and • discretionary expenses up to the indexed limit of $12,500 (as at 1 July 2020). Discretionary expenses include toiletries, recreation and leisure activities. Taxation • unexpended income of a Special Disability Trust is taxed at the beneficiary’s personal income tax rate, rather than the highest marginal tax rate. • capital gains tax exemption applies for any asset donated into a Special Disability Trust • a capital gains tax main residence exemption applies for Special Disability Trusts including where the main residence is disposed of within two years of the beneficiary’s death Further information on special disability trusts can be found at ¶19-300.

¶6-640 Income streams Prior to 1 July 2019, retirement income streams were classified into three categories based on their product features: 1) Assets test exempt income streams, which were purchased pre-20 September 2007, commutable in very limited circumstances and have nil residual capital value, eg lifetime income streams, life expectancy income streams and term allocated pensions.

Note Assets test exempt income streams are no longer able to be purchased except for defined benefit income streams and income streams purchased with the rollover of an asset test exempt income stream.

2) Assets tested income stream (long-term), which does not have the characteristics to be exempt from the assets test and which has an account balance or term of over five years, eg account-based pensions. 3) Assets tested income stream (short-term), which does not have the characteristics to be assets test exempt and which has a term of five years or less, eg short-term annuities. From 1 July 2019, a fourth category of income stream called lifetime income streams was added. 4) Lifetime income streams must be purchased on or after 1 July 2019. Once payments commence, they must continue for the remainder of the primary or reversionary beneficiary’s lifetime. Assets test exempt income streams

Income streams purchased prior to 20 Sept 2007 which met a number of restrictions such as being commutable in a very limited number of situations and no residual capital value — qualified for either a 50% or 100% asset test exemption. 100% asset test exemption Complying income streams purchased prior to 20 September 2004 qualified for 100% exemption from the assets test, including: • lifetime income streams — could have been purchased at any age • life expectancy income streams — must have been purchased over Age Pension or Service Pension age. The term must have equalled the person’s life expectancy (rounded up) if less than 15 years, or if life expectancy exceeded 15 years, between 15 years and life expectancy. 50% asset test exemption Complying income streams purchased between 20 September 2004 and 20 September 2007 qualify for 50% exemption from the assets test, including: • lifetime income streams • term allocated pensions (market linked income streams) • life expectancy income streams. Complying income streams purchased on or after 20 September 2007 do not qualify for assets test exemption. Income streams are discussed in detail in Chapter 16. Assets test The assets test value of complying income streams purchased between 20 September 2004 and 20 September 2007 is: • lifetime income streams — 50% of original purchase price reduced periodically (see purchase price depletion) • term allocated pensions — 50% account balance • life expectancy income streams — 50% of original purchase price reduced periodically (see purchase price depletion). Income test Under the income test for 50% and 100% asset test exempt income streams, the annual payment is reduced by a “deductible amount”. The “deductible amount” is calculated as: purchase price  relevant number  where: • Relevant number = term or life expectancy. Where the income stream does not have a specified term, the relevant number equals life expectancy (longest life expectancy if reversionary). There are additional requirements — these are discussed at ¶16-830.

Tip Defined benefit schemes, including public sector schemes such as the Commonwealth Superannuation Scheme (CSS), are classified as 100% assets test exempt income streams. Defined benefit schemes continue to receive a 100% assets test exemption even if they commence after 20 September 2007.

Pre-1998 lifetime income stream sourced from a defined benefit superannuation fund In order to satisfy the definition of a “defined benefit income stream” for social security purposes, a pre1998 lifetime income stream sourced from a defined benefit superannuation fund established before 20 September 1998 must satisfy the standards as set out in s 1.06(2)(a) to (d) and (f) to (h) of the Superannuation Industry (Supervision) Regulations 1994 pursuant to the Social Security (Income Stream) Determination 2017. For defined benefit schemes, the income to be taken into account for the income test is: gross annual income − tax-deductible amount

Note Due to the changes to the taxation of income streams that commenced 1 July 2007, the taxdeductible amount calculation also changed. Defined benefit income streams acquired from 1 July 2007 have their deductible amount calculated as a proportion based on “tax-free components”. For defined benefit income streams acquired before 1 July 2007, they retain the original deductible amount until: • 1 July 2007 if they have turned age 60 by the end of 30 June 2007 • the day they turn age 60 if under age 60 at the end of 30 June 2007.

10% limit on the deductible amount of a defined benefit income stream From 1 January 2016, the deductible amount of a defined benefit income stream is capped at 10% of the annual payment. The 10% cap only applies to people in receipt of income support payments from Centrelink. People receiving payments from Veterans Affairs such as the service pension are not impacted. In addition, defined benefit pensions paid by military superannuation funds are exempt from this measure. Example Bob and Nelly receive a part Age Pension and a defined benefit income stream. The defined benefit income stream has an annual payment of $50,000 and a tax-free percentage of 50%. Under the Centrelink income test from 1 January 2016, the deductible amount is limited to 10% of the annual payment, therefore assessable income is $45,000 ($50,000 – $5,000).

Assets tested income stream (long-term) Assets tested income streams (long-term) do not have the characteristics to be exempt from the assets test and have an account balance or a term of over five years, eg account-based pensions or annuities with a term greater than five years. Assets test

The value of these income streams for the purpose of the assets test will be calculated as either the: • account balance (eg account-based pensions or annuities), or • original purchase price depleted periodically (eg annuities). See purchase price depletion below. Income test The income test assessment of an asset tested income stream (long-term) is either: • deemed income from account-based pensions (see Deeming of account-based income streams from 1 January 2015), or • annual payment reduced by a “deductible amount”. Deeming of account-based income streams from 1 January 2015 Since 1 January 2015, account-based pensions that are not grandfathered (see below) are included in the definition of financial assets in social security legislation, which means they are subject to deeming rules for both Centrelink and DVA income test purposes. Applying the deeming rules to account-based pensions means that any payments a client takes will be ignored for income test purposes. Grandfathering of pre-2015 account-based pensions Grandfathering applies to account-based pensions where: • the person was receiving an income support payment immediately before 1 January 2015 and has continuously received an income support payment since that date, and • commenced the account-based pension before 1 January 2015 and retains the same account-based pension. Grandfathered account-based pensions are not subject to deeming. Rather assessable income is determined by: Annual payment reduced by a “deductible amount” (see “income test assessment” below for more information). Grandfathering also extends to a pre-2015 account-based pension that later automatically reverts to a reversionary beneficiary on the death of the original owner, provided that at the time of the reversion, the reversionary beneficiary is receiving an eligible income support payment. The reverted account-based pension will be subject to grandfathering into the future provided that it continues to be paid and the reversionary beneficiary continues to receive an eligible income support payment. Income support payment includes most Centrelink and DVA pensions and allowances, including the Age Pension, Service Pension, Disability Support Pension, Carer Payment and JobSeeker Payment. See ¶6-840 for more information and strategies regarding the deeming of account-based pensions. Income test assessment For asset tested income streams (long-term) that are not account-based pensions subject to deeming, the income test assessment is: Annual payment reduced by a “deductible amount”. Where the “deductible amount” is calculated as:  purchase price − commutations − RCV   relevant number  where:

• Commutations equals lump sum withdrawals since the date of commencement • RCV equals residual capital value • Relevant number equals term or life expectancy. Where the income stream does not have a specified term, the relevant number equals life expectancy (longest life expectancy if reversionary).

Tip For pensioners who have a grandfathered account based pension and choose to draw the minimum payment, little or no income is generally assessable in the initial years of the income stream as the deductible amount often exceeds the annual payment. In addition, due to the economic impacts of COVID-19, the government has reduced the minimum annual payment from account based pensions by 50%. Where clients reduce their annual payment under this measure it may result in less assessable income.

Example James purchased an account-based pension for $100,000 at age 65. The account-based pension is grandfathered as James purchased it prior to 1 January 2015 and has been continuously in receipt of the Age Pension since that time. James nominates to receive the minimum annual payment which is reduced by 50% for 2020/21 to 2.5% or $2,500. His assessable income is calculated as: $2,500 − ($100,000/18.54) = $0 His assets test assessment is determined by the account balance, which initially is $100,000.

Tip Where clients withdraw a lump sum from the account balance of a grandfathered account based pension, they will need to notify Centrelink as to whether the lump sum is a commutation. Otherwise the lump sum will be treated as an income payment under the income test, which could reduce their Centrelink entitlements. Note that lump sum commutations cause a recalculation of the deductible amount. The new deductible amount is calculated as the original purchase price minus the commutation divided by the original relevant number. Whether to take lump sums as a commutation or pension payment from a grandfathered accountbased pension can be an important decision. See ¶6-840 for more information.

Assets tested income stream (short-term) Assets tested income streams (short-term) do not have the characteristics to be assets test exempt and have a term of five years or less, eg short-term annuities. Under the income test, short-term income streams will be treated as financial investments and will accordingly be subject to the deeming provisions (¶6-600). The value of these income streams for the purpose of the assets test will be calculated as the original purchase price depleted periodically. Purchase price depletion

Where the income stream makes more than one payment per year, then the asset value is recalculated each half year, using the formula: PP − [((PP − RCV) / (RN × 2)) × completed half years] where: PP represents the purchase price of the income stream. RCV equals the residual capital value of the income stream. RN equals the relevant number of the income stream. Where the income stream is payable for a specified term, such as for life expectancy income streams, the relevant number equals the term. Where the income stream does not have a specified term, the relevant number equals life expectancy (longest life expectancy if reversionary). Completed half years represent the number of half-year periods that have passed since the commencement of the contract. For complying income streams purchased between 20 September 2004 and 19 September 2007, the asset value is 50% of the purchase price reduced by 50% of the depletion amount.

Note Where income payments are paid annually, no “half year” reduction is available. The formula would therefore become: PP−[((PP−RCV) / RN) × completed years]

Where the income stream contains 100% RCV, no reduction will occur. Lifetime income streams A new category of retirement income stream applies from 1 July 2019 — lifetime income streams. Lifetime income streams were added to cater for a new range of ”innovative retirement income stream products” that are expected to become available due to changes in superannuation and tax laws. Innovative retirement income streams include deferred annuities and group self-annuitised products that are designed to cater for longevity risk. Lifetime income streams also include immediate lifetime annuities. To qualify as a lifetime income stream, the income stream must be purchased on or after 1 July 2019, and once payments commence, they must continue for the remainder of the primary or reversionary beneficiary’s lifetime. Lifetime income streams include: • immediate lifetime annuities (superannuation and non-superannuation) • deferred lifetime annuities (superannuation and non-superannuation) • group self-annuitised products • lifetime superannuation pensions. Lifetime income streams do not include: • defined benefit income streams • fixed term annuities. All lifetime income streams purchased on or after 1 July 2019 are assessed under new income and

assets test rules. Grandfathering applies to lifetime income streams commenced prior to this date and they will continue to be assessed under the current means test treatment, ie asset tested (long-term) income streams. Under the new rules, lifetime income streams that comply with a “capital access schedule” receive a reduced assessable value under the social security assets test. A capital access schedule limits the amount of capital that can be accessed as a voluntary commutation or death benefit. See “capital access schedule” below. Social security assessment For lifetime income streams purchased on or after 1 July 2019 that comply with the capital access schedule, the social security assessment is: • assessable assets: 60% of the purchase price assessable until age 84 (or minimum five years), then 30% of the purchase price assessable for the remainder of their life • assessable income: 60% of annual payment. Example Angela purchases a lifetime income stream at age 66 for $100,000. Under the assets test, 60% of the purchase price ($60,000) is assessable until the age of 84 (19 years), after which point 30% ($30,000) is assessable. Angela receives $4,000 as an annual payment from the income stream. Under the income test, 60% ($2,400) is assessed as income. As payments increase due to indexation, 60% of the indexed payments will be assessable under the income test.

Capital access schedule When the government introduced “innovative retirement income stream products” into the superannuation and tax legislation, restrictions were placed on the amount that could be commuted from the income stream. In summary, the maximum amount that can be commuted as a voluntary surrender value is a declining straight line over the primary beneficiary’s life expectancy (or reversionary beneficiary’s life expectancy in certain circumstances). On death, the maximum amount that can be commuted is 100% of the purchase price within the first half of the primary beneficiary’s life expectancy, then after this date the declining straight line value applies. No amounts can be commuted from the income stream once they reach their life expectancy. The capital access schedule is important for social security purposes as lifetime income streams that comply receive a reduced assessable asset value (ie 60% of the purchase price assessable until age 84 (or minimum five years), then 30% of the purchase price assessable for the remainder of their life). What if they do not comply with the capital access schedule? Lifetime income streams purchased on or after 1 July 2019 that do not comply with the capital access schedule, that is, allow a higher amount to be commuted than the schedule allows, are assessed differently under the assets test. In this case, the assessable asset value of the lifetime income stream is the higher of: • current or future surrender value • current or future death benefit • 60% of the purchase price assessable until age 84 (or minimum five years), then 30% of the purchase price assessable for the remainder of their life. However under the income test, they are assessed in the same way as other lifetime income streams, that is, 60% of the annual payment is assessable.

¶6-660 Treatment of property investments

Property investments are not classified as financial investments and as such are not subject to deeming for income test purposes. Income from rental, leasing or letting of a property is assessed under the income test and any expenses and borrowing costs are subtracted from the assessed income. Centrelink or DVA can ask to see tax returns to determine the net rental for income test purposes. If the amount of expenses cannot be ascertained, Centrelink or DVA will allow a minimum of one-third of the rental as expenses. Most deductions for tax purposes are allowable for Centrelink purposes including interest expenses. However, the following deductions are allowed for tax purposes but not allowed for social security purposes: • capital depreciation • special building write-off • construction costs • borrowing costs. Example Mary receives an Age Pension and also owns an investment property rented for $300 per week. The property is valued at $200,000 and is mortgaged for $40,000 at 4%.

Income test $ Gross rental Less: one-third expenses Net rental

15,600 5,200 10,400

Less: interest cost

1,600

Assessed income

$8,800

Assets test $ Value of property Less: debt Asset value

200,000 40,000 $160,000

Some points to note: • the property must be the security for the loan for the net asset value to be assessable. In some cases unsecured loans can reduce the asset value where it is clear that the proceeds were used to purchase the property • capital gains arising from the sale of properties are not assessed as income for social security purposes • for life interests any rental received from the property is assessed as normal rental income if the person is required to maintain the property under the terms of the bequest • if a property is not rented no income is assessed.

Reverse mortgages For Centrelink and DVA purposes, reverse mortgages are known as “home equity conversion loans”. Reverse mortgages are a means of providing retirees with access to the equity in their homes. An important feature of a reverse mortgage is that the loan and interest are not repayable until the homeowner moves out of the home or dies. The Centrelink and DVA assessment of reverse mortgages depends on whether the clients take the proceeds as regular payments or a lump sum. Regular payments If the loan is taken as regular payments and the proceeds are spent straightaway on living expenses, the regular payments are not assessable under the Centrelink income or assets tests. However, care needs to be taken as some providers offer regular payments by holding the proceeds of the loan in an “offset account” or a secondary account. Where this occurs, the balance of the account would be treated as a lump sum amount (see below). Lump sum If the loan is taken as a lump sum, the first $40,000 is exempt from the assets test for 90 days. If the loan proceeds are still unspent after 90 days the loan amount becomes an assessable asset. If the loan proceeds exceed $40,000, the excess is assessable from day one. Under the income test, the unspent loan proceeds are subject to deeming immediately. Care needs to be taken with how the proceeds are spent. If they are invested in a financial investment they will be assessed as an asset and deemed. However, if they are spent on non-assessable items such as day-to-day expenses or repairs on the principal residence they will be exempt. Reverse mortgages are also discussed at ¶12-700.

¶6-670 Gifting rules Gifting or deprivation rules operate to assess certain assets, and income from those assets, when those assets have been disposed of for inadequate financial reward or given away. A single person or couple can dispose of assets up to $10,000 per financial year without affecting their entitlement to social security payments. Where assets exceed $10,000, the excess amount is included in the person’s assessable assets for the purpose of the assets test for a period of five years from the date of disposal. In addition, the excess amount is subject to “deeming” and included in the income test. In addition, gifting rules aimed at people who gift assets year after year apply. These rules limit the amount that can be gifted to $30,000 over a five-year rolling period, with gifts in excess of this free area assessed as a deprived asset for five years. This limit operates in conjunction with the $10,000 limit; however, provision has been made to ensure that a gifted amount is not double counted under both rules. Example Joan gifts $10,000 on 1 July every year for four years commencing 1 July 2020. To determine whether Joan is assessed under the gifting rules, both sets of rules must be applied. Rule One looks at whether Joan has gifted more than $10,000 per financial year. Rule Two looks at whether Joan has gifted more than $30,000 over a rolling five-year period.

Year

Gift

Rule One — Does the gift exceed $10,000 in  financial year? 

Rule Two — Do gifts in previous five years exceed $30,000?

1 July 2020

$10,000

No

No

1 July 2021

$10,000

No

No

1 July 2022

$10,000

No

No

1 July 2023

$10,000

No

Yes, total gifts of $40,000 exceed the threshold. $10,000 is then assessed as an asset and deemed for five years.

It is important to note that where the client has gifted assets in the five years prior to applying for a social security payment, the excess amount will be assessed under the gifting rules for five years from the date of the gift.

WAITING PERIODS ¶6-700 Waiting period rules There are a number of different waiting periods that a client may have to serve before they can receive a payment. If more than one waiting period applies, then the payment is not payable until all the waiting periods have ended. Most waiting periods are served concurrently and the end date is the day on which the longest period ends. There is one exception to this rule. The liquid assets waiting period (¶6-720) applies before the ordinary waiting period (these are not served concurrently). Therefore, a client could have a 13-week liquid assets waiting period but will have to wait 14 weeks, as they would have to serve the additional ordinary waiting period of one week after serving the 13 weeks.

¶6-705 Ordinary waiting period JobSeeker Payment, Youth Allowance (jobseekers) and Parenting Payment have an ordinary waiting period of one week. This means that all people applying for these benefits must wait at least one week before they can receive benefits. Note, due to the economic impacts of COVID-19, the government has waived the ordinary waiting period from 12 March to 31 December 2020. This waiting period can be waived if the person is returning to the benefit within 13 weeks of having received it previously or is in severe financial hardship. In addition, an eight-week non-payment period applies to JobSeeker Payment where the person voluntarily left their previous employment or was dismissed due to misconduct.

¶6-710 Compensation may affect social security Receiving a compensation payment may affect current or future social security payments. Social security payments are generally not made to a person who receives compensation which relates to lost earnings or lost capacity to earn. The compensation payment is regarded as money for living purposes. If the compensation is paid in a lump sum, there is a period of time when the person may not be eligible to receive payment. Compensation is defined as a payment which is made wholly or partly in respect of lost earnings or lost capacity to earn and if any settlement or part thereof includes an amount in respect of lost earnings a lump sum preclusion period needs to be calculated. If a lump sum is awarded by a court, the compensation component is used to calculate the provision. However, if the amount is settled out of court, the compensation component is deemed to be 50% of the settlement amount. The lump sum preclusion period can be calculated according to the formula:  compensation component   income cut-off amount 

The number of times the compensation component can be divided by the income cut-off amount is the number of weeks of the preclusion period. The income cut-off amount is approximately $1033.30 per week (at 1 July 2020). Example Janice received a lump sum compensation payment of $10,000. Assuming 50% is compensation for lost earnings, she will not be entitled to receive a payment until the end of her lump sum preclusion period:

 $5,000    $1033.30 

4 weeks*

* If the amount is not a whole number, it is to be rounded down to the nearest whole number.

This preclusion only applies to the recipient of the compensation; their partner is not affected. The preclusion period will normally commence on the date of the accident if the person is not receiving weekly compensation amounts. If the person is receiving periodic compensation amounts, the preclusion period will commence after the periodic compensation payments have ended. Most periodic compensation payments are counted as income by Centrelink; however, workers’ compensation payments cause a 100% social security payment reduction.

¶6-720 Liquid assets waiting period A person applying for JobSeeker Payment, Youth Allowance or Austudy may have to serve a liquid assets waiting period before receiving payment if the person has liquid assets above a certain amount. Note, due to the economic impacts of COVID-19, the government has waived the liquid assets waiting period from 25 March to 24 September 2020. Liquid assets include cash, term deposits, bank accounts and other investments that can easily be converted into cash. The liquid assets waiting period can be calculated using the following formula:  liquid assets−maximum reserve amount   divisor  A person will only be subject to a maximum waiting period of 13 weeks if the person holds liquid assets in excess of the maximum reserve amount. The liquid assets waiting period applies where a single person with no dependants has liquid assets exceeding $5,500 or a member of a couple has liquid assets exceeding $11,000. The divisor is $500 if the person is single and has no dependants; otherwise it is $1,000. This waiting period also applies to education leavers. Example Agnes, a single person with liquid assets of $7,000, applies for JobSeeker Payment. If the maximum reserve amount is $5,000, her waiting period will be:

 $7,000 − $5,000   $500 

Tip

= 4 weeks

A person affected by the liquid assets waiting period or their partner can make a payment on a debt after becoming unemployed or incapacitated, with the amount being disregarded in calculating their liquid asset level. This applies only if: • the debt is not related to the principal home or any other residential property • the payment is voluntary, and • the payment is the first voluntary payment made on that debt since the person became unemployed or incapacitated.

¶6-730 Income maintenance period If a person receives a payment for unused leave entitlements and applies for a social security payment, the person may be subject to an income maintenance period whereby the leave payments are treated as income from the date of payment. Leave entitlements include: • unused annual leave • unused long service leave • unused sick leave • employment termination payments, and • payments on bona fide redundancy. The income maintenance period is not like a normal waiting period and does not necessarily preclude a person from receiving a pension or allowance. Centrelink assesses the person’s previous salary for the number of days the leave payments represent. This means that if a person’s previous salary is less than the income cut-off point for the allowance being applied for then the client may be able to get a partial allowance during the income maintenance period. The income maintenance period applies to: • JobSeeker Payment • Partner Allowance • Widow Allowance • Parenting Payment • Youth Allowance • Austudy, and • Disability Support Pension. Example Clive has resigned from his employer after 20 years of full-time service. At resignation he was being paid $1,200 per week. While he worked, Clive used all his annual leave but never any of his long service leave. He now receives a payment of $20,400 on resignation for unused long service leave which represents 17 weeks payment. Clive’s income maintenance period is 17 weeks, during which time Centrelink assumes that Clive is receiving $1,200 per week.

Example Mary has been working permanent part-time at a bakery for 10 years. She is paid her six weeks’ outstanding annual leave and eight weeks long service leave. Mary receives a payment of $5,600. Her income maintenance period is 14 weeks with income of $400 per week. This level of income alone does not preclude her from applying for a JobSeeker Payment, but during the first 14 weeks she receives a reduced payment.

¶6-750 Newly arrived residents waiting period Many Centrelink payments have a waiting period for newly arrived residents. The NARWP was extended for a number of working age payments from 1 January 2019. The extended waiting period applies to people who were granted permanent or applicable temporary visas on or after 1 January 2019: • Increased from two to four years for Youth Allowance, Austudy, JobSeeker Payment, Special Benefit, Mobility Allowance and Pensioner Education Supplement and also for Low Income Health Care card and Commonwealth Seniors Health card. • A two-year NARWP commences to apply to Carer Payment, Parental Leave Pay and Dad and Partner Pay. • A one-year NARWP commences to apply to Carer Allowance and Family Tax Benefit part A, with no waiting period for Family Tax Benefit part B. Note, due to the economic impacts of COVID-19, the government has waived the NARWP from 25 March to 31 December 2020 for JobSeeker Payment, Youth Allowance, Parenting Payment, Austudy, Special Benefit and Farm Household Allowance. The NARWP starts from either the date the migrant arrives in Australia or the date of grant of permanent residence (whichever is the later). Refugees, their partners, and their dependent children are exempt from the waiting period. The Age Pension and DSP are not subject to this waiting period, but do have separate residential qualifications, which generally require a person to have 10 years residence. There are some exceptions if a person comes from a country with which Australia has a social security agreement or if the person becomes disabled after their arrival.

STRATEGIES, TIPS AND TRAPS ¶6-800 Social security strategies Clients who receive only a part pension or part allowance are affected by either the income test or assets test. Social security strategies have been broken down in the same way, based on which test is best dealt with by the strategy (although some strategies work for both income and assets tests purposes). Some strategies are riskier than others and this should be considered before implementation. Remember, the client should always check with Centrelink or DVA for their actual entitlement to benefits.

¶6-840 Income test strategies Income test problems often arise in regard to: • pension payments from a foreign pension or defined benefit superannuation fund (which may have little or no deductible amount for social security), and • deeming on financial assets.

Where generous pension payments are being paid from the employer’s superannuation fund, there is little that can be done other than making sure that financial assets subject to deeming are reduced. To reduce the impact of deemed income counting from financial assets, there are a couple of strategies to consider (which involve having financial assets classified as something else). Investment in land or rental property While most financial planners would not recommend that a client invest in a block of land, you should be aware that land and rental property are not subject to deeming. Centrelink counts the actual income generated from the property less a deduction for expenses. Vacant, non-primary production land does not generate any income.

Tip The interest expense for any borrowing used to obtain the investment can be deducted from the rent earned. This applies regardless of whether the loan is secured against the investment or an exempt asset. Centrelink will also allow a deduction for expenses or, if not known, a one-third deduction for expenses.

⊠ Trap For the assets test, Centrelink will reduce the value of the asset counted by the amount of the borrowing if it is secured against the assessable asset. The borrowing cannot be a primary or secondary mortgage on the principal place of residence! Borrowing on the principal residence is ignored and therefore the client’s real net asset value will be overstated. In some cases, unsecured loans can reduce the net asset value where it can be shown that the funds were used to purchase the assessable asset.

Example Bruce and Anne are both on part Age Pensions as the bulk of their money is invested in a term deposit, which is deemed. Their term deposit money totals $400,000 and has been deemed to earn $7,240 pa. They want to buy a rental unit with some of this money (using only $250,000 of their own money and borrowing the extra $50,000). Figures are current as at 1 July 2020. Their assets would be as follows:

$  Rental unit

300,000 

Less: borrowing, secured against the unit

(50,000) 

Term deposit

150,000 

  TOTAL

$400,000 

Their income would be assessed as follows: Rental income at 4.5%

13,500 

Less: interest on borrowing (6%)

(3,000)

Less: expenses (⅓)

(4,500)

Deemed income on $150,000 term deposit   TOTAL

1,615 $7,615 

Account-based pensions Deeming of account-based pensions from 1 January 2015 Since 1 January 2015, account-based pensions (that are not grandfathered) are included in the definition of financial assets in social security legislation, which means they are subject to deeming rules for both Centrelink and DVA income test purposes. The actual level of pension payments drawn from a deemed account-based pension does not impact a client’s income test assessment as only the deemed income is assessable. In some cases, such as where a client draws a high level of pension payments they may have less assessable income if their account-based pension is deemed rather than grandfathered. Grandfathering Account-based pensions commenced prior to 1 January 2015 retain the previous income test treatment (ie annual payment less deductible amount) where the client received an eligible income support payment immediately before 1 January 2015. This treatment will continue to apply provided the account-based pension continues and the client continues to receive an eligible income support payment. Grandfathering also extends to a pre-2015 account-based pension that later automatically reverts to a reversionary beneficiary on the death of the original owner, provided that at the time of reversion, the reversionary beneficiary is receiving an eligible income support payment. The account-based pension will continue to be grandfathered provided it continues to be paid and the reversionary beneficiary continues to receive an eligible income support payment. An eligible “income support payment” includes most Centrelink and DVA pensions and allowances, including the Age Pension, Service Pension, Disability Support Pension, Carer Payment and JobSeeker Payment. It does not include Health Care Cards. Take care with grandfathered account-based pensions Clients with grandfathered account-based pensions may have little or no assessable income from their account-based pension for income test purposes by drawing a pension payment close to the deductible amount. For these clients, if their account-based pension becomes subject to deeming, it may result in an increase in total assessable income. Example Jane is a single homeowner with an account-based pension. Jane’s assessable assets are:

Account-based pension Household contents Total

$260,000 $5,000 $265,000

As her assessable assets are under the assets test threshold of $268,000, she will receive the maximum Age Pension under the assets test. Under the income test, if Jane’s account-based pension is grandfathered, Jane has minimal assessable income as her annual payment of $12,250 less her deductible amount of $10,000 provides assessable income of $2,250, which results in the maximum Age Pension. However, if her account-based pension becomes subject to deeming, the deemed income of $4,790.00 is assessable. This results in a reduction in her Age Pension entitlement of $4.12 pf. When assessing the impact of an account-based pension losing grandfathering, it is important to consider both current and future impacts. While deeming rates are currently at historically low levels, if they increase in the future the impact on a client’s Age Pension entitlements could be significant.

What could cause an account-based pension to lose grandfathering? The following circumstances could cause an account-based pension to lose grandfathering: • ceasing to qualify for an income support payment

• ceasing the grandfathered account-based pension • death. Ceasing to qualify for an income support payment If a client loses entitlement to an income support payment for any reason, even where there is only a short gap in payment, they will lose grandfathering on their account-based pension. For example, if a client has seasonal employment where their earnings cause the Age Pension to cease for a period of time they will lose grandfathering on their account-based pension. Ceasing the grandfathered account-based pension If a grandfathered account-based pension is commuted for any reason, such as rolling to another pension provider, it will lose its grandfathered status. Death Where a reversionary beneficiary has not been nominated, on death a grandfathered account-based pension will lose its grandfathered status. If a new account-based pension is paid on death to a beneficiary, it will be subject to deeming. If a reversionary beneficiary has been nominated, the account-based pension will retain its grandfathered status on reversion as long as the beneficiary is in receipt of an income support payment at the time of reversion. Some superannuation funds may allow a reversionary beneficiary to be added to an existing accountbased pension without commuting and recommencing the income stream. It is important to check with the superannuation fund whether this option is available. If a reversionary beneficiary is added to a grandfathered income stream without commuting and recommencing a new income stream, it will retain its grandfathered status, however, the deductible amount may be re-calculated. The deductible amount will be recalculated to include the longest life expectancy and the original purchase price at commencement. Example James commenced an account-based pension in 2010 at age 65 with a purchase price of $100,000. James deductible amount is $100,000 / 18.54 = $5,393 In 2020, James adds his wife Rebecca as a reversionary beneficiary to the existing account-based pension without commuting and recommencing the account-based pension. As James is continuously in receipt of Age Pension since 1 January 2015, the accountbased pension retains it grandfathered status. As Rebecca has been added as a reversionary beneficiary, the deductible amount needs to be recalculated using the original purchase price and longest life expectancy at commencement. In 2010, Rebecca was also age 65 and her life expectancy was 21.62. The new deductible amount that applies from the date Rebecca was added as a beneficiary is: $100,000 / 21.62 = $4,625.

Grandfathered assessment of account-based pensions Where a client has a grandfathered account-based pension, there are a number of strategic considerations: What if the client needs more income? Careful consideration needs to be given if the client requires additional income. Clients have the choice of selecting additional pension payments or a taking an additional lump sum amount from their account-based pension and advising Centrelink or DVA accordingly.

Lump sum payment — the advantage of taking the additional payment as a lump sum commutation is that it will not be assessable under the income test. In addition, it will reduce the account balance of the pension which reduces assessable assets (assuming the lump sum is spent and not invested). However, lump sum commutations do cause a reduction in the deductible amount which may increase assessable income in future years. The deductible amount will be recalculated as: (Original purchase price – lump sum commutations) / original relevant number Additional pension payment — the advantage of taking the additional payment as a pension payment is that it does not cause a reduction in the deductible amount. However, the additional pension payments will be assessable under the income test for the remainder of the financial year. This may significantly reduce their Centrelink entitlements, particularly if they are income tested. One possible solution is to time the additional pension payment to occur near the end of the financial year, so that it only affects their Centrelink entitlements for a limited period of time.

⊠ Trap Care should be taken as although Centrelink determine the assessable income from an accountbased pension on a financial year basis, it will not be until August that the superannuation fund electronically reports the new financial years information to Centrelink, which means that their Centrelink entitlements may be reduced until this time.

Example Paul receives the Age Pension. Paul has a grandfathered account-based pension with a purchase price of $300,000. He requires an annual pension payment of $40,000 to meet his income needs. Deductible amount = $300,000 / 18.54 = $16,181 Options: 1. Regular pension payment of $40,000 pa – Assessable income ($40,000 − $16,181 = $23,819 pa) – Age Pension reduces under the income test 2. Draw regular pension equal to deductible amount of $16,181. Draw the remaining $23,819 as a lump sum withdrawal – Assessable income ($16,181 − $16,181 = $0) – Lump sum withdrawal permanently reduces deductible amount from $16,181 to $14,896.

In all cases it is important to calculate the client’s entitlement under both the assets and income test to determine the effect of either a lump sum commutation or increased pension payment. The difficulty is that the effect of the reduced deductible amount may not reduce entitlements until a number of years in the future.

¶6-860 Assets test strategies For allowance recipients, once assets exceed the limit, there is no entitlement to any benefits. Therefore it is very important to ensure that a client’s assets are below the limit if they are to receive any Centrelink benefits. For pension recipients, assets over the lower threshold reduce their entitlement by $3 per fortnight per $1,000 over the lower asset threshold.

Asset test reduction strategies To improve an assets-test sensitive client’s situation, a financial planner can choose one of the following options or a combination of both: • arrange the client’s investments so as to produce more income, or • change assessable assets to exempt or reduce assessable assets. Obviously, the first option is straightforward financial planning. The second option requires the use of various strategies and products where part or all of their value is ignored for assets test purposes. Often, using these strategies and products can also improve a client’s income test situation. The following strategies are outlined below: • superannuation • gifting • funeral bonds. Superannuation Superannuation has long been the best strategy for clients wanting some social security benefits as it is only means tested once a client has reached Age Pension age (¶6-610). The key strategies with superannuation revolve around whether: • a person is under Age Pension age, or • their spouse is under Age Pension age. (1) Leave money in superannuation where client is under Age Pension age, or contribute more In many cases clients will already have money in superannuation when they apply for a social security benefit. If the client has money in superannuation, and is under Age Pension age, this asset will be ignored for both the assets test and income test (¶6-610). If the client has other financial assets, they may be able to contribute this money to superannuation and increase their benefits.

Tip If clients have some unrestricted non-preserved benefits and want to take a cash withdrawal, no part of this amount is included in the income test.

⊠ Trap All contributions to superannuation and earnings are preserved. If the client is unable to meet the retirement condition of release, an alternative condition of release may be available if they have received income support (a pension or allowance) continuously for 26 weeks and they are in severe financial hardship or they are over their preservation age and received benefits for nine months or more.

(2) Spouse contribution to younger spouse who is under Age Pension age

Couples have the opportunity to transfer assets to a younger spouse’s superannuation, and have it treated as an exempt asset.

Tip Transferring assets between a couple is not gifting (deprivation). This strategy only works if the spouse is under Age Pension age. Once the spouse reaches Age Pension age the superannuation money will be means tested.

⊠ Trap Contributions are preserved until the spouse meets a condition of release. If the spouse meets a retirement condition of release such as “over preservation age and permanently retired” or “over 60 and ceased a gainful employment arrangement since turning 60”, then they can access their benefits. However, if the spouse has never worked, they may not be able to access their superannuation until age 65, as they cannot meet a retirement condition of release.

Gifting (deprivation of assets) The Social Security Act and the Veterans’ Entitlements Act consider that everything a person owns or has a right to has a value. If your client gives away or sells one of their assets without receiving its full value or adequate consideration in return, then Centrelink and DVA considers this as deprivation of an asset. Deprived assets are treated as financial assets for the next five years. The industry refers to this as “gifting”. A single person or couple can dispose of assets up to $10,000 per financial year without affecting their entitlement to social security payments. Where assets exceed $10,000, the excess amount is included in the person’s assessable assets for the purpose of the assets test for a period of five years from the date of disposal. In addition, the excess amount is subject to “deeming” and included in the income test. In addition, to the $10,000 per financial year limit, there are other gifting rules aimed at people who gift assets year after year apply. These rules limit the amount that can be gifted to $30,000 over a five-year rolling period, with gifts in excess of this free area assessed as a deprived asset for five years. This limit operates in conjunction with the $10,000 limit; however, provision has been made to ensure that a gifted amount is not double counted under both rules.

Tip Deprivation does not apply to contributions to superannuation or giving money to your spouse.

Gifting $10,000 each financial year (three years out of five) As discussed above the gifting rules limit the amount that can be gifted to $30,000 over a five-year period. By gifting $10,000 per financial year for three years out of five, both gifting rules are satisfied. This gifting can occur in several ways — a payment of cash, forgiveness of a loan or a transfer of ownership of an asset. Gifting significant assets before applying for a pension or benefit

As discussed above, if clients deprive themselves of a significant asset it continues to be considered a financial asset for the next five years. However, clients can avoid this by depriving themselves of the assets more than five years before they apply to Centrelink or DVA.

⊠ Trap If you give money away do not expect to get it back! If clients need assets to sustain their lifestyle in retirement then it may be best to ignore Centrelink benefits and maximise returns on the asset. It is not enough to loan money to someone — this is still a financial asset.

Example Wendy and William are married and looking to retirement. They will reach Age Pension age in five years’ time. They plan to continue to work for the next five years. They have two children, both in their late twenties. Their assets now are:

$ Home

400,000

Wendy’s superannuation

150,000

William’s superannuation

150,000

Other assets (cars/boats)

50,000

Investment property

600,000

If they retain the investment property they will not be entitled to the Age Pension when they reach Age Pension age as their assets exceed the limit. However, they have decided to give the investment property to their children now (they were planning to leave it to them in their wills anyway). If they give away the investment property on 1 July 2020, the effect in five years’ time is as follows: Assessable assets as at 1 July 2025 (when they leave work assuming superannuation grows at approximately 7% pa net):

$ Wendy’s superannuation

210,383

William’s superannuation

210,383

Other assets

50,000

TOTAL ASSESSABLE ASSETS

$470,766

Assume the lower asset threshold is indexed to $465,448 by 1 July 2025 (indexed at 3% pa):

$ Assets over the limit

Nil

Reduction for assets

Nil

Maximum Age Pension 825.17 (pf each; also indexed at 3% pa) Age Pension

825.17 (pf each)

Funeral bond An effective strategy to reduce assessable assets is for clients to prepay their funeral expenses or invest in a funeral bond — as the funds may be exempt under both the asset and income test. Funeral bonds costing up to $13,500 (as at 1 July 2020) are exempt. The number of bonds the client can own is no longer limited to one bond, however, only two bonds can be exempt. The client can choose

which bonds will be exempt. When determining the cost of a funeral bond, it is the original sum paid plus any additional payments or instalments, but importantly it does not include interest. This means that if the value of the funeral bond exceeds the limit, then in the future it will not become assessable.

LIFE AND PERSONAL RISK INSURANCE The big picture

¶7-000

Overview of life insurance The role of life insurance

¶7-050

Term insurance policies

¶7-055

Permanent insurance policies

¶7-060

The importance of life insurance The underinsurance problem

¶7-070

The incidence of death and disability

¶7-075

The players in life insurance Key definitions in life insurance

¶7-080

Term life insurance What is life insurance (death) cover?

¶7-100

Tax implications for death cover

¶7-150

Total and permanent disability insurance (TPD) What is total and permanent disability (TPD) insurance?

¶7-200

Definitions of TPD

¶7-210

Stand-alone or bundled (linked) TPD

¶7-220

Tax implications for TPD

¶7-230

Trauma insurance What is trauma insurance?

¶7-250

Tax implications for trauma cover

¶7-270

Income protection What is income protection?

¶7-300

Cancellable and non-cancellable income protection policies

¶7-310

Level of cover (agreed or indemnity) for income protection

¶7-320

Waiting period and benefit periods for income protection

¶7-340

APRA changes to income protection proposed from 1 July 2021

¶7-345

Tax implications for income protection

¶7-350

Personal sickness and accident insurance

¶7-360

Is income protection needed?

¶7-370

Applying for insurance cover The insurance application process

¶7-400

The underwriting role and process

¶7-410

Disclosure requirements for life insurance

¶7-450

Acceptance of the insurance policy

¶7-460

Ongoing obligations of the life insurance company

¶7-470

Selecting the amount of cover required How much insurance is appropriate?

¶7-500

Client needs analysis

¶7-510

Calculating the recommended insurance amount

¶7-520

Insurance for businesses What if the client runs a business?

¶7-600

Business expenses insurance

¶7-610

Key person insurance Identifying a key person

¶7-650

Benefits of a key person insurance policy

¶7-660

Structuring key person policies

¶7-670

Tax implications for key person

¶7-680

Case study — key person

¶7-690

Business succession planning Overview of business succession planning

¶7-700

The components of a buy/sell plan

¶7-710

Structuring buy/sell insurance

¶7-720

Tax implications for buy/sell arrangements

¶7-760

Life insurance inside superannuation Overview of insurance inside superannuation

¶7-800

The structure of insurance inside superannuation

¶7-810

The advantages and disadvantages of insurance inside superannuation for nonbusiness reasons

¶7-820

Meeting the sole purpose test

¶7-830

Funding premiums inside superannuation

¶7-840

Tax deductions for premiums in superannuation

¶7-850

Taxation of insurance through superannuation

¶7-860

Cross-insurance and self managed superannuation funds

¶7-870

Superannuation reserving strategies

¶7-880

Insurance in super and low-balance or inactive accounts

¶7-890

Stepped versus level premiums Premium options for life insurance

¶7-900

Stepped premiums

¶7-905

Level premiums

¶7-910

Group insurance cover

What is group insurance?

¶7-930

Benefits offered under group policies

¶7-935

Continuation option

¶7-940

Advantages and disadvantages of group policies

¶7-950

Claims process Lodging an insurance claim

¶7-960

Verifying an insurance claim

¶7-965

Investigation and surveillance

¶7-970

Insurance policy waiting periods

¶7-975

Comparing claims performance

¶7-978

Life insurance complaints process Raising a life insurance complaint

¶7-980

Complaints for insurance inside superannuation

¶7-985

Life insurance framework and remuneration reforms Life insurance framework

¶7-990

Life insurance commissions and conflicted remuneration

¶7-995

ASIC sample life insurance SOA

¶7-997

Life insurance codes of practice

¶7-998

Recommendations from the Royal Commission

¶7-999

¶7-000 Life and personal risk insurance

The big picture This chapter provides an overview of the types of insurance available, strategies in relation to ownership and purpose of insurance and the main features to consider when making recommendations on life insurance. The importance of life insurance: Underinsurance is a major problem within Australia and advice is important to create increased awareness of the need for life insurance ¶7-070. Term life insurance: provides benefits upon death but may also pay a claim upon meeting terminal illness diagnosis ¶7-100. Total and permanent disability (TPD) insurance: provides benefits when a person is permanently incapacitated and can be covered under an any occupation, own occupation or modified definition ¶7-200. Trauma (or critical illness) insurance: provides benefits if a critical illness is suffered to help with the costs and recovery ¶7-250. Income protection Income protection replaces income during periods of incapacity when the person is unable to work ¶7-300. The policy covers a percentage of salary on an agreed or indemnity basis ¶7-320. Consideration needs to be given to waiting periods and benefit payment periods ¶7-340.

Applying for insurance cover A large part of the application process focuses on medical and financial underwriting so that the insurance company can determine if they want to take on the risk and under what terms ¶7-410. During this process, the client is required to provide full and complete disclosure of all relevant details ¶7-450. Selecting the amount of cover required The advice process needs to consider a full needs analysis for the client ¶7-510. The needs analysis should be used to determine the appropriate amount of cover ¶7-520. Insurance for businesses Business expense insurance can keep the business running by providing cover to pay operational expenses while the owner is unable to work ¶7-610. Key person insurance can cover the loss of revenue resulting from the incapacity or death of a key person in the business ¶7-650. Buy/sell arrangements focus on the use of insurance to help fund business succession plans ¶7-700. Life insurance inside superannuation Clients can choose to hold insurance inside superannuation, but advantages and disadvantages should be compared ¶7-800. It is always important to ensure the sole purpose test is not breached ¶7-830. This can help to reduce the effective cost of premiums ¶7-840. The Australian Tax Office’s (ATO’s) view is that reserving strategies, including those using insurance, cannot be used by self managed superannuation funds (SMSFs) ¶7-880. Industry and legislation reforms aim to ensure life insurance inside superannuation is appropriate and not diminishing small superannuation balances ¶7-890. Stepped versus level premiums Stepped premiums may provide cheaper premiums in earlier years but the cost increases each year ¶7-905. Level premiums may be more expensive in earlier years but can reduce the cost of insurance over longer periods of cover ¶7-910. Group insurance cover Group cover offers insurance under a group policy rather than individual policies and is most commonly offered through corporate super funds ¶7-930. Advantages arise from automatic acceptance ¶7-935. The claims process and complaints When a claim is lodged, the life company will undertake a full review and look for inconsistencies that indicate non-disclosure at the time of application ¶7-960. Complaints processes are available ¶7-980. Life insurance remuneration reforms: The government has passed legislation to reform the remuneration framework of the life insurance industry (¶7-995) but ongoing reviews and scrutiny are likely following the Life Insurance Industry Report ¶7-990. The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry has had an impact on all areas of financial services and advice, including life insurance ¶7999.

OVERVIEW OF LIFE INSURANCE ¶7-050 The role of life insurance An effective wealth planning strategy should include two aspects: • investment management — to accumulate savings, manage taxation and meet financial objectives, and • wealth protection — to minimise the financial risks and interruptions that would arise if the person suffers ill-health or injury or death. Wealth protection can be achieved with the implementation of a life insurance plan. This plan should first consider the implications that would arise following the person’s death or disability (either temporary or permanent) and the consequences that would arise from either loss of earnings or increased expenses. This focuses on the question of how would that person and/or their family cope financially if illness, injury or death occurred? The next step is to take into account the resources that would be available to meet financial needs and then identify the “risk gap”. This gap can be filled by taking out appropriate life insurance policies. Life insurance policies are broadly grouped into term insurance policies and permanent insurance policies.

¶7-055 Term insurance policies Term insurance policies are current for a fixed term and can be renewed at the end of that term. This term is generally the period of time that the premium is paid for and the renewal occurs through the payment of the next premium. If premiums stop the policy is cancelled. In Australia, term life policies are generally guaranteed renewable. Once the risk has been accepted by the life insurance company and a policy document has been issued, the life company cannot cancel the cover until the policy expiry age or condition, providing the policy owner continues to pay the premiums when due and the client has disclosed everything required by law. Term insurance policies will comprise the following policy types: • term life (or death cover) • total and permanent disability (TPD) • income protection (also known as salary continuation), and • trauma cover (also known as critical illness cover). Policies can be tailored to the client’s specific needs by considering features and benefits offered on the policy. These may be standard features or optional features. Prices can vary widely depending on the life company’s pricing policy, underwriting requirements and optional features selected.

¶7-060 Permanent insurance policies With the widespread coverage of superannuation in Australia, permanent insurance policies are no longer popular and are generally not available. Permanent insurance policies are also known as whole of life, endowment or universal life policies. The term “permanent life insurance” is used to define a policy that provides risk protection for the insured’s entire life unless the policy is surrendered. Permanent insurance policies provide protection for the life insured’s entire life and accumulate a cash value as well as a death value. This is different to term insurance policies (¶7-055) as the insurance

company may eventually need to make a payment in one form or another under a permanent insurance policy. Policy owners can borrow against the cash value. If premiums stop, a policy with a cash value can be classified as “fully paid-up” and continue to remain in place, albeit with an adjusted death value. The policy owner could also choose to surrender the policy and receive the termination value of the policy to invest elsewhere. This may be at a discount to the death value and the client should weigh up the financial merits and financial needs. This chapter focuses only on term life policies.

THE IMPORTANCE OF LIFE INSURANCE ¶7-070 The underinsurance problem Australia has an underinsurance problem. A report issued by RiceWarner (Underinsurance in Australia 2017) shows that the level of life insurance was improving largely due to life insurance inside superannuation which accounts for 70% of Australians with life insurance. However, underinsurance is still a major problem. This report states that the life cover held by an average Australian would meet only 47% of their family’s basic needs. The basic needs are defined as non-mortgage debt and sustaining the current standard of living until age 65 or until children reach age 21. It also found that only one-third of the working population have income protection; the median level of income protection cover met only 21% of needs and the median total and permanent disability cover met 14% of needs. The report estimates that underinsurance for death cover is estimated to cost the government $54m each year, with the cost of disability much higher at $500m per year for TPD underinsurance and $692m per year for income protection underinsurance. A 2014 KPMG study (Underinsurance: Disability Protection Gap in Australia) also examined the incidence of underinsurance and found that 35% of people did not have any disability insurance cover at all. The most underinsured group is the 45–64 year age group. Although the quantum of these studies could be argued as being too high or too low, most studies into the level of insurance cover in Australia agree that Australians generally do not have adequate insurance in place. The level of underinsurance could arise due to financial difficulty in financing premiums or the lack of value attached to the cover. Many superannuation policies include a basic level of insurance cover and people may be under a misguided belief that this is sufficient cover without ever having undertaken a risk needs analysis. Underinsurance or the lack of insurance may also arise from a person’s reluctance to accept that a tragic event may occur to them. A serious medical illness or injury can prove a greater financial burden on a family than a death. Not only do everyday living expenses continue but additional expenses associated with the condition may also arise.

¶7-075 The incidence of death and disability • Australia’s life expectancy is among the highest in the world. For females, life expectancy if born in 2016–2018 was 84.9 years and for males it was 80.7. The median age at death in 2016 for men was 78 and for women was 85 (Australian Bureau of Statistics 2019 (ABS 2019) and Australian Institute of Health and Welfare (AIHW), Deaths in Australia 2019). • Coronary artery disease has been trending downwards as a cause of death over the last 40 years but is still the leading cause of death for males. It was the cause of 11.6% of deaths overall in 2017.

• Dementia, including Alzheimer’s disease, has overtaken cerebrovascular disease (notably stroke) as the second most common underlying cause of death in Australia with the rate of deaths increasing over the past decade by 68%. Dementia is now the leading cause of death for women with twice as many women as men dying from dementia in 2017. • Cerebrovascular diseases, chronic lower respiratory diseases and cancer of the trachea, bronchus and lung, complete the top five causes of death. The top five causes account for 36.7% of deaths. • The incidence of cancer deaths is declining overall and survival time is increasing but as a group of diseases, cancer is still the second most common cause of death in Australia. The risk of dying from cancer is one in four for males and one in six for females, and is now likely to kill more middle-aged Australians than cardiovascular disease. • Just under one in five Australians are reported as having a disability in 2016, and just over a quarter of these needed help with the basic daily living activities. • Approximately 1.2 million Australians had diabetes in 2015, with 85% being Type 2. • In 2015 more than 11 million Australians had at least one of eight selected chronic diseases and around 23% of the population had two or more of these diseases. • Suicide has become the leading cause of death for people aged 15–45 with land transport accidents and poisoning coming second and third. Under age 14, land transport accidents are the prominent cause of death. • Fatal burden is defined by the AIHW as the impact of dying prematurely from disease and injury. It is measured in terms of years of lost life due to premature death. In Australia in 2015, there were 2.4 million years of lost life from all diseases. The causes can vary for various age groups but overall the leading causes were coronary heart disease, dementia, lung cancer and suicide or self-inflicted injuries. (Sources: Australia’s Health 2018 — AIHW, ABS 3303.0 Causes of Death Australia, 2017, AIHW Leading Causes of Death 2016 and AIHW Australian Burden of Disease Study 2015: fatal burden preliminary estimates)

THE PLAYERS IN LIFE INSURANCE ¶7-080 Key definitions in life insurance APRA The Australian Prudential Regulation Authority (APRA) supervises life insurance companies that are registered under the Life Insurance Act 1995. It has responsibility to establish and enforce prudential standards and practices to ensure promises made by life insurance companies (and other financial institutions) are met and the financial system is efficient and stable. Life insurance company A company that offers life insurance policies to the public. Re-insurers A life insurance company can reduce the level of risk it holds on underwritten policies by transferring portions of risk portfolios to other parties under a contractual agreement. These other parties are called reinsurance companies (re-insurers). The life company pays a fee to the re-insurer to take on some of the risk. If certain levels of claims are paid during a year, the re-insurer will reimburse the life company for the agreed portion of the claims. The underwriter

The underwriter is employed by the life insurance company to assess the financial and medical circumstances for a life insurance applicant to determine whether the policy will be accepted and under what conditions. The aim is to manage the overall risk for the insurance company and to ensure that the cost of the cover is proportional to the risks faced by the applicant. Life insured This is the person whose life and/or health is covered under the policy. Claims are paid if this person meets the claim requirements. Policy owner(s) This person (or entity) is the legal owner of the life insurance policy. Once the policy is accepted and in place, this person (entity) has the right to cancel the policy, apply for modifications and pay the premiums to continue the policy. If a claim is made, proceeds are paid to the policy owner if still alive. Beneficiaries The person(s) nominated on the policy document to receive claim proceeds if the policy owner is deceased. Product Disclosure Statement The Product Disclosure Statement (PDS) provides the client with an understanding of the features and benefits on offer under the insurance policy. It indicates what is on offer under the policy. It should be provided to clients with any advice recommendations. Policy document The policy document outlines the terms and conditions of the life insurance offer and should be read in conjunction with the explanations in the PDS. Any specific modifications or terms that apply to a particular policy are outlined in the Policy Schedule which is attached to the policy document. The policy document and policy schedule form the insurance policy for the client.

TERM LIFE INSURANCE ¶7-100 What is life insurance (death) cover? Term life insurance provides a lump sum payment upon the death of the life insured. Payment is made to the nominated beneficiaries, or to the estate if no beneficiaries are nominated. Policies that cover insurance upon death may also provide a terminal illness payment clause. This allows a claim to be approved and paid if the life insured is suffering a terminal illness that is expected to cause death within the following 12 months. Terminal illness policies are not typically sold as stand-alone policies. Term life insurance is used to help dependants with the financial loss caused by the life insured’s death. This may include objectives such as: • repayment of debts • replacement of income • lump sums to cover additional expenses (such as funeral or child care) • to provide for future needs of children. Terminal illness payouts Most term life policies include a terminal illness benefit. If the terminal illness criteria are met the policy will be paid out. This is not additional to the death benefit but rather is an advance on the death benefit. Payment of a terminal illness claim will therefore cancel (or reduce) the death cover under a life policy.

The policy document will specify the definition and criteria that needs to be met. This generally involves assurance that the death is likely to occur within 12 months. This assurance will require medical certification as specified. The terminal illness benefit is paid to the policy owner rather than the beneficiary who would have received the death benefit. The tax implications for a terminal illness payment on a non-superannuation life insurance policy are the same as a payment made on death of the life insured. But if the life insured has not passed away, capital gains tax implications could arise if the benefit was paid to someone other than the life insured or defined relative (¶7-150). If the terminal illness payment is paid from a policy held inside superannuation it is paid as a tax-free lump sum to the member who is the life insured (¶7-860).

¶7-150 Tax implications for death cover The premiums paid for term life are not tax deductible, except in some business situations (¶7-680) and (¶7-760) or if the policy is held inside superannuation (¶7-860). Any payments received under a successful claim on a personal insurance policy are also not taxable income and do not need to be declared on the person’s tax return. Different rules may apply if the policy was held for business succession purposes or if held inside superannuation.

TOTAL AND PERMANENT DISABILITY INSURANCE (TPD) ¶7-200 What is total and permanent disability (TPD) insurance? Total and permanent disability (TPD) insurance provides a lump sum payment if the life insured meets the policy definition of totally and permanently disabled. TPD insurance is used to help the life insured and dependants with the financial loss caused by the life insured’s permanent incapacity to resume working or homemaking duties. This may include objectives such as: • repayment of debts • replacement of income • lump sums to cover additional expenses (such as personal care or medical expenses) • to provide for future needs of children. The premiums for TPD policies are often lower than a comparable amount of life cover because the incidence and risk factors are generally lower, but this will depend on the individual client and occupation type.

¶7-210 Definitions of TPD The definition of TPD varies between policies but generally means the person is permanently unable to work again. Own occupation or any occupation The event may be covered under an “own occupation” definition or an “any occupation” definition: • Own occupation — unable to work again in the person’s own specific occupation. • Any occupation — unable to work again in any occupation for which the person is reasonably suited by education, training or experience.

The premiums for own occupation definitions are generally higher than any occupation definitions as the chance of being able to make a claim is increased. Own occupation definitions are likely to be more suited to a person in a professional or semi-skilled occupation. Example A surgeon injures his hand and is no longer able to operate. If his TPD policy had an any occupation definition it would not become payable if he was still able to work as a general practitioner (GP). However, if the policy had an own occupation definition it may be payable.

Non-workers and homemakers In addition to these two occupation assessments, TPD policies may also include modified definitions which can provide cover for non-workers or homemakers. These definitions consider loss of function assessment and/or activity assessments with conditions such as: • loss of sight or use of limbs • inability to perform two activities of daily living without assistance: – bathing and showering – dressing and undressing – eating and drinking – continence and personal hygiene – getting in and out of bed – moving from place to place (walking or wheelchair). Example Alison is a homemaker and suffers a stroke. She has partially recovered but is unable to bathe or dress on her own or to feed herself. The TPD policy had a homemaker definition covering loss of ability to perform daily living activities and the claim is approved. This will provide funds to help with Alison’s care or to replace her home duties.

Allowed definitions for superannuation policies Since 1 July 2014, new TPD policies taken out inside superannuation can only be taken with an any occupation definition (¶7-800). Partial TPD TPD policies may offer a partial payment of the insured amount where the full claim condition has not been met such as the loss of a single limb or sight in one eye. These outcomes may not prevent the person from working again but may have a significant impact on lifestyle. These options may not be available inside superannuation.

¶7-220 Stand-alone or bundled (linked) TPD TPD can be offered as a bundled (or linked) option on a life insurance policy or it can be offered as a stand-alone policy. Bundled or linked TPD If bundled on a life policy, the amount of TPD cover may not be able to exceed the amount of death cover. If a TPD benefit is paid, the value of any death cover may be reduced by an equivalent amount; however, the policy may offer the following options to minimise this impact:

• Life cover buy back — for an additional cost, the reduced life cover can be bought back after a period of time (usually 12 months) from the TPD claim has passed, without further medical underwriting. In some policies this may be a standard feature. In other policies it is an additional cost at the time an application is made to reinstate the cover. • Double TPD option — this is an option that may be selected at commencement for an increased premium. If a TPD claim is paid, the reduced portion of life cover is reinstated more quickly (although a survival period may still apply) and premiums are no longer paid on the reinstated amount. Example Harry takes out a bundled life/TPD insurance policy with $1.5m life cover and $1m TPD cover. Three years later, Harry is involved in a serious motor vehicle accident. The life insurance company is satisfied that he meets the criteria for TPD and pays the $1m claim proceeds. His remaining life cover is subsequently reduced to $500,000 under the policy terms. The insurance policy includes a buy-back feature. A year later, Harry has survived the accident and pays to take up this option to restore his life cover back to $1.5m to protect his family in case of his death. This option may be cheaper than taking the double TPD option at commencement, but Harry takes on additional risk. If he dies before the 12 months has elapsed, his family will receive a reduced life insurance payout.

TPD may also be offered as an option on a trauma policy. Stand-alone policy The benefit of a stand-alone TPD policy is the full flexibility to choose separate levels of death and TPD cover to meet the needs of the client. The cost may be higher to have two separate policies. Other benefits of a stand-alone policy include: • ability to separate ownership of death and TPD cover — eg hold death cover inside super and TPD outside super to eliminate problems with tax or if an own occupation policy is required • independent claim assessments so that a TPD payout will not reduce the remaining level of death cover.

¶7-230 Tax implications for TPD The premiums paid for TPD insurance are not tax deductible, except in some business situations (¶7-680 and ¶7-760) or to the fund trustee if the policy is held inside superannuation (¶7-860). Any payments received under a successful claim by the life insured are also not taxable income if paid to the life insured and do not need to be declared on that person’s tax return. Different rules may apply if the policy was held for business succession purposes (¶7-700) or if held inside superannuation (¶7-800).

TRAUMA INSURANCE ¶7-250 What is trauma insurance? Trauma insurance provides a lump sum payment if a specified medical condition occurs. Trauma cover can be added as an option (a rider) on a term life or total and permanent disability policy or can be taken as a separate stand-alone policy. Trauma insurance is used to help the life insured and his/her family during periods of treatment and recovery by providing a lump sum to meet objectives such as: • repayment of debts • replacement of income during the treatment and recovery period

• lump sums to cover medical treatment and travel expenses • provide for holidays to recover or allow the family to spend time together. The premiums for trauma policies are generally higher than a comparable amount of life cover because the incidence and risk factors are generally higher. Trauma claim events The types of trauma events covered will vary across policies. The policy document will list the claimable medical events and any level of diagnosis that is required for a successful claim. The most common conditions covered include cancer, heart attack and stroke. Under some policies, a partial claim may be made for various levels or an illness or injury.

¶7-270 Tax implications for trauma cover The premiums paid for trauma insurance are not tax deductible, except in some business situations (¶7680 and ¶7-760). Any payments received under a successful claim by the life insured are also not taxable income and do not need to be declared on the person’s tax return. Different rules may apply if the policy was held for business succession purposes or if held inside superannuation.

INCOME PROTECTION ¶7-300 What is income protection? Income protection is a life insurance policy that pays regular income while the life insured is sick or injured and unable to work. It is often called salary continuation insurance, particularly when offered inside superannuation. This may be a temporary or permanent period of incapacity. Although, if the capacity is permanent, some policies may convert the income payments into a lump sum and finalise the policy after a period of time. Income protection is used to help the life insured and his/her family during periods of incapacity by replacing employment income to meet ongoing living expenses. Income protection policies may also include extra benefits, such as rehabilitation benefits. Some may be automatic benefits which are provided at no extra charge, but some are optional benefits which are available for an additional cost.

¶7-310 Cancellable and non-cancellable income protection policies It is important to check whether an income protection policy is cancellable or non-cancellable. If non-cancellable, once the policy is accepted by the insurer it is automatically renewable irrespective of any claims history. Under a cancellable policy, the insurer maintains the right to cancel the policy at renewal if the insurer deems that the individual (or the group under an employer policy) is now an unacceptable risk. The premium for a non-cancellable policy is likely to be higher than a comparable cancellable policy.

¶7-320 Level of cover (agreed or indemnity) for income protection The level of cover is set as a percentage of salary. Policies commonly pay up to 75%–80% of salary. Some policies may pay an extra amount into superannuation so that retirement savings continue to grow. Cover historically has been provided on an indemnity basis or on an agreed basis, but recent changes put in place by APRA mean life insurance providers stopped offering agreed value policies from 1 April 2020. This change is aimed at stemming losses experienced in disability insurance business to help the industry

remain sustainable. Indemnity value policy Under an indemnity contract a monthly claim limit is agreed at commencement of the policy. If a successful claim is made, the actual monthly benefit is assessed at claim time as the average earnings over the 12 months prior to the claim. This creates uncertainties over whether the level of cover paid for will be provided at claim time. In particular, the risk that a person who suffers a serious condition may continue to work for a period but generate lower income during this period (resulting in a lower payout) may lead to a preference to retain an agreed value policy. Example Ted applies for an income protection policy which has an indemnity value and will pay up to 75% of the pre-disability income. At the time of application his previous year’s salary was $80,000 per annum. Ted accepts a policy with a maximum insurance benefit of $5,000 per month. Ted becomes ill and struggles to maintain his work. He reduces his hours and drops his income to an average of $70,000 over the year. Ted’s health continues to decline and he eventually needs to stop working. As it was an indemnity policy, his claim benefit is based on 75% of his income over the 12 months prior to claim. Although he paid for a benefit up to $5,000 per month, he will only be eligible to receive $4,375 per month.

Agreed value policy An agreed value policy verifies at commencement of the policy how much is payable if a successful claim is made based on average earnings at commencement of the policy. This amount is payable even if income has dropped before the claim is lodged. Example Ted applies for an income protection policy which has an agreed value based on a maximum of 75% of his current income. At the time of application, his previous year’s salary was $80,000 per annum. Ted accepts a policy with an agreed insurance benefit of $5,000 per month. At the time of claim, he would be eligible for a claim benefit of $5,000 per month, even though his pre-disability income drops to $70,000 per annum.

An agreed value policy had greater upfront financial underwriting requirements with evidence of income generally required during the application process. This option was not available in all client situations (eg may not be offered to someone just setting up their own business due to the uncertainty in their expected income). Agreed contracts usually charge higher premiums but provide greater certainty. New policies are not offered under agreed value terms from 1 April 2020. Offset clauses Income protection policies may include offset clauses which allow the monthly payments to be reduced by other income received, such as sick leave or Centrelink benefits. Contracts should be reviewed carefully.

¶7-340 Waiting period and benefit periods for income protection When selecting the appropriate features for a policy, two important decisions are options for the waiting period and the benefit period. Waiting period This is the time that the life insured must be unable to work before payments start. Policies generally offer a choice between 14 days and up to two years. A longer waiting period can reduce the cost but the person will need to have other resources (such as savings or sick leave) to meet their needs during this waiting period. Benefit period

This is the maximum time the claim payments will continue to be paid. The choice is generally for payment periods of two or five years or up to age 65. Choosing a longer period increases the cost but may provide greater protection.

¶7-345 APRA changes to income protection proposed from 1 July 2021 In December 2019, APRA as the regulator of life insurers proposed changes to features of income protection policies. This intervention is aimed at stemming ongoing losses in income protection insurance to make the market more sustainable. The proposed changes will only impact new policies. These changes aim to address what are considered to be excessively generous features of insurance policies and act as a deterrent to returning to work. Agreed value policies are no longer sold from 1 April 2020, but other measures proposed from 1 July 2021 include the following: • Policies will no longer be guaranteed renewable. Instead, the insurer will be able to review the terms and conditions every five years based on a reassessment of the insured’s income and occupation position. • Policies which offer long-term benefit periods (such as to age 65) should include stricter disability definitions to limit the ongoing claims. • Payouts on policies will be based on income earned over the 12 months prior to the claim (not averaged over several previous years). • Limiting benefit payments to no more than 100% of earnings at the time of claim for the first six months and then no more than 75% after six months.

¶7-350 Tax implications for income protection The premiums paid for income protection are tax deductible. This can help to reduce the effective cost. Example Estelle is a 40-year-old receptionist living in Victoria. She earns $60,000 per year which puts her in the 32.5% marginal tax rate plus Medicare. In the 2020/21 financial year, she pays a premium of $2,000 for her income protection policy. Estelle is eligible to claim a tax deduction for the premium which saves her $690 in tax. This reduces the effective cost to only $1,310 after tax.

Any payments received under a successful claim are taxable income and need to be declared on the person’s tax return. PAYG tax instalments are generally not deducted by the life insurance company, so the person needs to allow for tax to be paid and is likely to enter into the PAYG instalment system if payments continue in subsequent years.

Note Income protection can be held inside superannuation. If payments are paid by a superannuation fund trustee, PAYG instalments will generally be deducted from each payment (¶7-860).

¶7-360 Personal sickness and accident insurance Sickness and accident insurance policies are offered by general insurance companies rather than life insurance companies. They can be taken as sickness-only or accident-only or combination policies.

These policies may offer cover up to 100% of the insured’s income but are underwritten on an indemnity condition. This means that evidence of income earned over the 12 months prior to the claim needs to be verified at the time of claim and is used to determine the claim amount. Claims are usually only paid for up to two or five years. The policies may offer a zero-day waiting period, in which case they start paying a benefit from day one of the disability, but they often then have a maximum benefit per total disability claim. The policies are cancellable which means that the insurance company can decline to offer a renewal if there are changes in the insured’s health or occupation. They usually also have a wider range of exclusions than an income protection policy.

¶7-370 Is income protection needed? Income protection provides continued income if income from employment stops due to illness or injury. Workers’ compensation can replace a person’s salary but only if the inability to work arises due to an accident that happens at work. Clients have a higher chance of not working due to illness or an accident that happens away from work and these are events not covered by workers’ compensation. Most people also do not have significant levels of accumulated sick leave. Without income protection, once sick leave is used up the clients may need to start drawing on savings or apply for a payment from Centrelink. Private health insurance may help to cover the cost of medical treatment, but it would not replace lost income. Example How much is a client’s income potential worth? Consider a client who earns $70,000 per year today and this increases by 3% inflation each year. Over the next 20 years they would earn a total of $2.5m. If the client’s income is $40,000 per year, this would total almost $1.5m over the next 20 years. Imagine the financial impact of losing access to that potential income! Clients need to weigh up the cost of insurance premiums against the potential value of the loss and the likelihood of making a claim. The cost of insurance can be substantial and may not always be affordable. Clients also need to take into consideration any replacement income sources such as Centrelink benefits, workers’ compensation or drawing down on savings that could be used as alternatives.

APPLYING FOR INSURANCE COVER ¶7-400 The insurance application process The first step in the application process is to complete an application form and a personal statement. This requests details in relation to: • age • residency • occupation • financial situation • pursuits and pastimes • medical history. Applicants with complicated medical histories or a higher risk of developing chronic disease or work in higher risk occupations may need to complete additional forms or undergo further medical testing.

Clients have a duty of disclosure to ensure all information is provided accurately and honestly. Advisers have a responsibility to explain the duty of disclosure to clients and to ensure any information they are aware of that may impact an insurer’s decision has been disclosed. Every question in the personal statement should be answered (as required) to minimise process delays and to ensure full disclosure.

¶7-410 The underwriting role and process In processing the completed application form, the application is likely to undergo some form of underwriting. The extent and processes may vary across providers and will depend on the risk assessment made for each policy. Underwriting is the process of assessing risk to ensure the cost of the cover is proportionate to the risks faced by the individual and the insurance provider. In this way it aims to manage the level of risk that the insurance company takes on. Underwriting for life insurance generally has two components: • medical underwriting, and • financial underwriting. The medical underwriting assesses the likelihood of an insurable event occurring to determine whether the risk will be accepted and the pricing. The financial underwriting is used to validate and justify the level of insurance cover that is applied for to ensure that the client is not seen to be profiting from an event. The levels of insurance applied for need to be demonstrated as appropriate for the client’s circumstances and needs. As an outcome of the underwriting process the life insurance company may: • accept the risk on standard terms and issue a policy • decline to provide cover and reject the application, or • make an offer to accept the risk on conditional terms (ie with exclusions or premium loadings) for the applicant to consider. The risk factors When assessing an application, the following risk factors can influence the outcomes: • Age: Older applicants represent a higher level of risk and premiums are charged accordingly. • Smoking status: Premiums are usually significantly higher for smokers due to the higher chance of critical illness. • Genetic medical history: If the family history indicates an incidence of serious illness (eg cancer or heart conditions) the risk may be assessed as high and may incur premium loadings or rejection. • Personal health conditions: An applicant in good health with no serious medical history may be assessed as a lower risk and be accepted on standard terms. The application may be refused if regular illness is apparent or exclude some current conditions (eg back problems). • The nature of the occupation: Applicants employed in jobs that are considered to be more dangerous or are prone to physical injuries/illness may be considered higher risk and be excluded from certain types of insurance or incur premium loadings. Clients who have more risk factors than average may only be offered a policy if they accept premium loadings or exclusion clauses. Identifying factors that may contribute to these outcomes and managing client expectations may save a lot of time and stress.

Life insurance companies generally produce underwriting guidelines which can be referred to when assisting clients with an application. This may help to set client expectations in relation to information requests that will arise or decisions that the underwriters are likely to make. It can also help with selecting an appropriate product provider. Medical underwriting Part of the application form will include a personal statement which asks for all details of medical history and family medical history. The underwriter may also request permission to obtain medical history details from the applicant’s medical practitioner and may require the applicant to undergo further medical examinations or blood tests or provide further information. The medical underwriting requirements may include: • personal statement — completed by applicant with questions on occupation, travel, residency, income, health, family history and lifestyle • additional questionnaires for certain illnesses and injuries such as asthma, mental disorders and back injuries • blood tests — testing for glucose, liver function, lipids and renal function, AIDS/HIV antibody test, hepatitis, full blood count • paramedical or own doctor examination • personal Medical Attendant’s Report completed by usual doctor from medical records • exercise ECG. The extent and range of testing is likely to depend on the applicant’s age, weight, family history and amount and type of cover applied for. Medical examinations are most likely to be requested where: • the client’s body mass index (BMI) is outside an accepted healthy weight range • the client may not have had a medical check-up in recent years • the client has a history of medical issues or there are inconsistencies in the personal statement • the client is applying for large sums of insurance (ranges are normally specified in the underwriting guidelines). Genetic testing Applicants are required to disclose all known medical history and other information requested by the life insurance company. However, the use of genetic testing has been a controversial topic of debate within the life insurance industry. In an effort to increase consumer protections, the Financial Services Council (FSC) introduced a moratorium on life insurance genetic test results as Standard Number 11 to apply from 1 July 2019. This is binding on insurance companies who are members of the FSC. This Standard mandated that: • life insurers are not able to ask an applicant to undertake a genetic test (even with the promise of lower premiums) • if an applicant has undertaken genetic testing before applying for cover, they are not required to provide the results to the insurer if the testing was conducted for medical research and the applicant is not aware of the results • insurance providers may only ask for and use the results of a previously undertaken genetic test if the

person is applying for cover that takes aggregated insurance cover above the following thresholds: – Life or TPD: $500,000 – Trauma: $200,000 – Income protection: $4,000 per month • to access details of previous genetic testing, the insurer needs written permission and must advise the applicant why the information is necessary and who it will be disclosed to, and • the results of genetic testing can only be used to assess the person who underwent testing and not any relatives of that person. One life insurance company is not able to share the results of genetic testing with another life insurance company due to privacy laws. Strict standards of privacy, confidentiality and data security need to be applied by the insurer. This moratorium will be in place until at least 30 June 2024, but a review is expected in 2022. Financial underwriting The purpose of financial underwriting is to ensure that the amount of insurance applied for is consistent with the applicant’s needs and can be justified by the current situation and not an opportunistic view of what the future could look like. Insurers aim to avoid over-insurance. The test the underwriter may apply is to measure whether the claim would leave the policy owner (or beneficiary) in a better financial position than if the life insured continued to live or remained in good health. In cases where large amounts of cover are applied for, noting the reason and justification for the amount on the application can assist the underwriting process. Inclusion of the Statement of Advice with the application documents may help to provide this information if it can show: • the client’s current financial position • needs analysis • details of insurance policies recommended • how the sum insured was calculated. Financial underwriting is also important for applications for income protection. Evidence of income derived from employment is considered to ensure the level of insurance applied for is appropriate, particularly with agreed value policies. Forward underwriting When a client takes out life insurance cover, they should consider needs both now and into the future. Future events such as starting a family or taking on debt may result in the need for higher levels of insurance cover. However, by waiting to take out this cover at a later date, the client is taking on risk that the increase may be declined or the premium loaded if a serious illness has been diagnosed or an injury has occurred before the application for additional cover is accepted. Insurance providers may offer a forward underwriting option to solve this problem. This option allows clients to secure the option to buy extra cover (up to an agreed limit) in the future based on their current health, without further medical underwriting when the increase is applied for. The decision to exercise the option to purchase the additional cover needs to be triggered by: • a business event — such as starting a new business or increase in business share, or • a personal event — such as marriage, permanent separation or birth of a child.

In some cases, the option to purchase the additional insurance may be offered on a periodic basis, for example every third year. The amount of additional insurance that can be purchased and the trigger events will be specified in policy documents. An additional premium is payable to add this feature to a policy. Example Phil has recently married and is applying for life insurance to cover the mortgage on their new home and to provide some security for his wife if he passes away. At this stage they decide they need cover of around $600,000. Phil is healthy and is able to secure the cover at standard rates. They are planning to start a family in a few years and he recognises that would increase the level of cover needed. However, Phil is reluctant to pay for more cover than he currently needs. Phil selects a forward underwriting option. This allows him to increase his cover by a further $400,000 if a specified personal or business event occurs. Further medical underwriting would not be required at that time so he is guaranteed to be able to secure the additional cover at standard rates. He is happy to pay the additional premium now for that feature to be approved.

Underwriting focus for the insurance types The level of detail and extent of underwriting requirements can vary between companies and products, but the underwriting guidelines issued by each company can help with the efficiency of this process. The table below provides a quick guide to the main issues and focus of underwriting by insurance type. Insurance type

Main issue

Life cover

The underwriting process may be less difficult for death cover than for disability and critical illness. Therefore, it is possible that an application for TPD or trauma is declined but death cover is approved. Underwriting will focus on the client’s age and relative health for that age. Medical history and family history are important considerations. The sum insured is assessed in relation to the client’s current financial situation and needs analysis to cover debts and/or provide for dependants.

TPD

Focus is on the risks from an occupation or hobbies that might lead to disability and applies a similar underwriting process to income protection.

Trauma cover

Family history of illness is a prime consideration as this may indicate a genetic predisposition for a condition. Occupations and hobbies are less important as the conditions covered are less likely to arise from these activities. Clients employed in higher risk occupations may find it easier to be approved for Trauma than TPD, for example home duties and police officers. Large sums insured may generate a request to justify the level of cover. Insurers often ask for a needs analysis if the application is for more than $2m of cover.

Income protection

The main concerns focus around the person’s occupation and work history. The health history is used as an indication of potential future health issues. The level of income is important as part of the justification for the level of cover. Regularity of the income is also important to ensure that a claim is replacing income and is not just an opportunistic event. Clients who have erratic business cashflows or have just started self-employment or work from home may find it difficult to obtain income protection or may be limited to indemnity cover only.

¶7-450 Disclosure requirements for life insurance Applicants for life insurance have a legal obligation to fully disclose all requested information honestly and accurately under the Insurance Contracts Act 1984. It is important that all information is disclosed even if it seems immaterial to the level of risk. If it is discovered that information was not disclosed or the information provided was inaccurate, the insurance company could refuse to pay any claims or pay a reduced claim. A proposed Duty of Disclosure Bill will amend the disclosure requirements to create a new duty that requires a person to take reasonable care not to make a misrepresentation to the insurer before entering into, varying or renewing an insurance contract if obtained for personal or domestic use. If passed as proposed, this will apply to contracts entered into from 5 April 2021. Pre-existing medical conditions Non-disclosure of pre-existing medical conditions is one of the main causes of disputes in life insurance claims. If the condition is not disclosed as part of the application process, the life insurance company may refuse to pay any claims, even if the condition is not related to the condition causing the claim. A pre-existing medical condition is considered to be one that before commencement of the policy or the effective date of any increase in the sum insured was: • a condition that has been previously diagnosed or investigated • symptoms were evident before application and subsequently led to a diagnosis or claim event. It is important to note that the full conditions of disclosure apply up to the point when the application is approved and the policy commences, not just until the application is submitted.

¶7-460 Acceptance of the insurance policy The insurance policy does not come into force until the risk cover has been accepted by the insurer and the first premium has been paid. Once accepted, the insurer will issue a policy document and schedule of cover to the policy owner. The policy includes: • the PDS and any supplementary disclosure statements issued • the policy document (often combined with the PDS) • the policy schedule • the application, and • any other endorsements or notices provided by the life insurer in writing. The policy document is a generic document that applies to all policy owners, while the schedule details the specifics of that person’s cover. The policy schedule will include: • policy owner, life insured and nominated beneficiaries • policy commencement date • details of premiums payable • policy number, and • details of any restrictions on the policy or premium loadings. The policy document and schedule should be retained by the client in a safe place. These documents

form the terms and conditions for the insurance policy and will need to be returned when a claim is made. Interim cover While a policy is going through the underwriting process, the insurance provider may provide the applicant with interim cover. This is usually a restricted level of cover with details provided in the PDS. Often the cover is limited to only accidental death. Cooling-off period Once a policy commences the policy owner has a cooling-off period of 30 days. If they decide not to continue with the cover they can cancel within this period and received a refund of all premiums paid. Cancellation of the policy The policy will be cancelled at the earlier of the following dates: • the policy owner requests a cancellation • the policy is cancelled by the insurance provider due to non-payment of premiums • a claim is paid which cancels the policy • the life insured reaches the cancellation age specified in the policy document • the policy owner exercises the cooling-off period to void the policy.

¶7-470 Ongoing obligations of the life insurance company Some of the duties of the insurance provider include: Changes to policy terms Insurance companies need to provide full disclosure of any changes to insurance plans and policies, well in advance of the change, particularly if the change is likely to have an adverse effect on policy holders. If notification is not made of any changes, this would open the possibility for a challenge to any outcomes. Changes to premiums Premiums may increase each year if a stepped premium option is selected (¶7-905). The changes are in accordance with a fee schedule set by the insurance company and any loadings applied and accepted on the policy. From time to time, the company may review its overall pricing structure. The insurance company must provide details to all policy holders with adequate notice of any change. Policy expiry The insurance company has an obligation to advise a policy holder of an upcoming expiry date and provide an opportunity to renew. Any changes in terms and conditions or policy features should be advised at that time. If the policy has an automatic renewal in place, it is up to the policy holder to notify the insurance company if they wish to cancel.

SELECTING THE AMOUNT OF COVER REQUIRED ¶7-500 How much insurance is appropriate? Determining the amount of insurance that is appropriate for a client is based on a needs analysis. There are many different models used by advisers to provide recommendations on appropriate insurance levels but they all focus on providing cover for the following purposes:

• replace the income stream that the person was generating before the insured event to cover ongoing expenses and personal goals • provide a lump sum to repay debt to decrease the financial pressure on the person and/or their family so the asset can be retained • pay any expenses that arise out of the occurrence of the insured event, such as medical expenses, recovery time, care expenses, funeral expenses or home modifications. If the insurance claim creates any tax liabilities, the client may wish to increase the level of cover to provide an additional insurance amount to pay this tax. It is also important to consider the expenses that would arise if the client dies or suffers a serious illness or disability even if that person is not currently earning an income. Clients may want to insure for these expenses. Example Tara is a full-time homemaker caring for her husband and their three children. The youngest child has just started school. If Tara passed away or became disabled the family would not lose any income, but the family may incur additional expenses to not only care for Tara (if disabled) but also to replace the care she provides in the home and to her children. Tara and her husband decide to take out a life and TPD insurance policy to provide a lump sum that could be used to provide for the care needs of Tara and the children if an event occurs. This may allow them to hire a carer or replace income so her husband can take time off work to provide the care.

Insurance companies may ask to see a justification for any levels of insurance applied for as part of the underwriting process to ensure that the amount is reasonable given the client’s personal situation and is not just opportunistic (¶7-410).

¶7-510 Client needs analysis The adviser should undertake a needs analysis for the client to determine their personal and financial situation. This should include a discussion on personal, financial and medical issues covering: • their current financial situation (including assets and liabilities) • their current income sources and how much is related to personal exertion • options available to replace income if the client is unable to work due to death, illness or injury • personal and family goals, objectives and concerns for the future financial security of their family • an overview of their personal and family medical history and the potential for medical issues to arise • existing insurance policies through employment, superannuation or other purchased policies. It is important that full documentation is maintained of all facts collected and used to base recommendations as well as to document the important personal issues discussed that have led to specific insurance recommendations. This information should then be used to develop specific recommendations for insurance type, amounts of insurance, policy ownership structure, insurance provider (may vary according to policy type) and optional features to select. This should be prepared as a Statement of Advice (SoA) for the client. When discussing the recommendations with the client, the client may decide to reduce insurance levels to reduce the cost of the insurance. The adviser should document in file notes the circumstances of the discussion and the reason behind any changes in actions taken from recommendations made. Any recommendations made can only be representative of a snapshot view at the current time based on estimations. It is important to ensure that regular reviews and updates are recommended.

¶7-520 Calculating the recommended insurance amount Many insurance companies have calculators, tools and formulae for determining an appropriate level of insurance cover for clients. These can be useful to calculate the amount that is to be recommended for a client. Calculation methodology The process for calculating the recommended amount may use one of the following methods: 1. Replacement method — determining the potential salary that would be lost over the remaining working life of the client and insuring this amount. 2. Expenses method — looking at what vital expenses are ahead and calculating a dollar value to insure to cover these expenses. The process may also use a combination of these options. In calculating the insurance amount consideration may be given to: • providing an income for each dependent child for a period of years • repaying debts • covering potential school fees and education costs for children • the impact of inflation on expenses • the future potential for salary increases • the costs that would be incurred if the insured event occurs • tax and other expenses that would no longer apply (eg reduce salary to net salary) or tax that may be payable on claim benefits. Case study Iris currently earns $80,000 per annum. She is 50 years of age and was planning to work for another 10 years. She is married and has two children in high school (ages 12 and 14). In total Iris and her husband estimate it will cost them a further $60,000 to educate their children. They have a home loan of $400,000 but no other debts. Iris has $230,000 accumulated in superannuation and her fund provides a $100,000 insurance policy for death and permanent disability. A needs analysis for Iris determines that she needs death, TPD and trauma cover as well as income protection. In determining the level of insurance cover needed, two potential options are discussed below. Note: This case study is a simplistic outline of methods to calculate insurance recommendations. These are not the only options available and may not include all considerations. They are shown as an indication of how appropriate levels of cover could be calculated. Option 1 — replacement method Iris expects to work for another 10 years at approximately the same income level, assuming increases each year for 2% inflation. Insurance cover is calculated on the basis of replacing her earning capacity.

$ Future income (over 10 years)

876,000

Less: estimated tax plus Medicare (ignoring offsets)

217,000

Potential lost income

$659,000

Death cover recommended:

Replace lost income so family lifestyle is not interrupted

659,000

Less: Available insurance

100,000

Less: Superannuation death benefit

230,000

Plus: Funeral expenses

15,000

Plus: Lump sum for family holiday and/or husband to take time to grieve and spend with family

100,000 $444,000

TPD cover recommended:

Replace lost income so family lifestyle is not interrupted

659,000

Less: Available insurance

100,000

Plus: Medical/home modification expenses

80,000

Plus: Lump sum to provide for care needs

200,000 $839,000

Trauma cover recommended:

Replace lost net income for one year

60,000

Plus: Medical expenses

100,000

Plus: Lump sum for recovery time to spend with family

50,000 $210,000

TPD cover recommended:

Replace 75% of income plus SG

$5,000 per month plus super contribution of $475 per month

Note: tax is estimated based on 2020/21 marginal tax rates but ignores tax offsets. Option 2 — expenses method Iris’s husband generates enough income to cover the family’s living expenses provided the bigger items of education, holidays and other major unusual expenses are covered and the family is debt free. Insurance cover is calculated on the basis of covering the expenses the family needs Iris to cover. Death cover recommended:

$ Provide $8,000 pa (indexed) income for each child to age 21

137,000

Cover education costs

60,000

Funeral expenses

15,000

Repay mortgage

400,000

Plus: Lump sum for family holiday and/or husband to take time to grieve and spend with family

100,000 712,000

Less: Available insurance and super death benefit

330,000 $382,000

TPD cover recommended:

Provide $8,000 pa (indexed) income to each child to age 21

137,000

Cover education costs

60,000

Medical/home modification expenses

80,000

Repay mortgage

400,000

Lump sum to provide care needs

200,000 $877,000

Trauma cover recommended:

Children income/education for one year

25,000

Plus: Medical expenses

100,000

Plus: Lump sum for recovery time to spend with family

50,000

Plus: Mortgage for one year

40,000 $215,000

TPD cover recommended:

Replace 75% of income plus SG

$5,000 per month plus super contribution of $475 per month

INSURANCE FOR BUSINESSES ¶7-600 What if the client runs a business? Income protection can cover income for a person and their family if they are unable to work. But if they run a business, they probably have fixed business costs that still need to be paid. If these expenses are not paid, they may not have a business or a job to go back to when they get better. Business succession is also important to consider for a business. If there is more than one owner of the business, the consequences could be significant if an owner becomes ill or dies and an effective business succession plan is not in place. This plan needs two components: • a buy/sell agreement — to set the terms of the succession plan • a funding mechanism — usually appropriate insurance policies are put in place to provide the funds to put the buy/sell arrangements into effect. When designing a plan that provides protection for business owners, three areas should be considered to ensure needs are comprehensively covered: • Keep the business running — Key person cover (¶7-650) or business expenses insurance (¶7-610) are two insurance options that can provide funds to pay expenses, repay debts or replace lost revenue to keep a business financially viable while either restructuring, selling or waiting for the person to recover. • Succession planning — A buy/sell arrangement (¶7-700) will facilitate the orderly transfer of the business from an owner who is no longer able to continue due to death or disability, to the remaining owners. • Protection for the person and family — This may be through personal insurances (death, TPD, trauma or income protection), or a plan to ensure the business can continue to generate revenue to meet the family needs.

¶7-610 Business expenses insurance

Business expenses insurance is similar to income protection but is designed to cover the fixed daily costs of running a business if the business owner (life insured) is unable to work due to illness or injury. The life insured must be working in the business as a sole trader, partner in a partnership or working director of a company. If a successful claim is made, the benefit is paid as a monthly reimbursement of fixed business expenses up to the agreed monthly limit. Depending on policy conditions, the policy may cover a full reimbursement or only a partial reimbursement.

Tip Business expenses insurance is different from business interruption insurance, which pays a monthly amount for business expenses if an event such as fire or water damage causes the business to close for a period of time.

Waiting periods and benefit periods A waiting period will generally apply before claim proceeds can commence to be paid. This can be selected between 14 days and 90 days. The shorter the waiting period, the higher is the premium. Successful claims will only commence to be paid for expenses incurred after the life insured has been absent from work for this waiting period. Claims are generally only paid for a maximum of 12 months. Some policies may have a return to work feature which allows the owner to return to work for a certain number of hours (generally up to 10 hours a week) without affecting the ability to claim benefits. This allows the owner to keep in touch with staff and clients. Amount of cover and eligible expenses The expenses that can be covered under the policy may include: • employing a locum to keep the business running • rent on business premises • staff salaries for staff who do not generate business revenue (for example, receptionist or administration staff) • business loans and overdrafts • leases on motor vehicles or equipment • business insurances • accounting and audit fees • advertising expenses • utility bills such as electricity, gas and telephone. If a claim is made, receipts for the eligible expenses paid will need to be submitted each month to validate the reimbursement amount. Taxation implications The policy needs to be held by the business. The premiums for business expenses insurance are tax deductible.

Any claim benefits paid are included as taxable income of the business, but expenses paid from these amounts are tax deductible as per the normal course of business. Case study Business expenses Elroy runs a plumbing business as a sole trader. He employs an admin assistant and operates from an office. He also has a lease on his work van. Elroy’s business income averages $12,000 per month and his expenses are $4,000 per month. This provides him with a gross income of $8,000 per month. Elroy has a heart attack and is unable to work for several months while he recovers. During this period there is no income coming into the business but most of his business expenses continue. Fortunately, Elroy has an income protection policy in place that pays him 75% of his personal employment income (ie $6,000 per month) for up to five years. This allows his family to continue to cover living expenses for that period. He also has a business expenses policy for up to $4,000 per month. He makes a successful claim on that policy to cover his rent, electricity, phone, lease payments, assistant’s wages and superannuation guarantee and other eligible expenses for up to 12 months. This will allow his business to keep running so that he has a business to return to when he recovers. Both policies will start to pay benefits once the respective waiting periods have elapsed.

KEY PERSON INSURANCE ¶7-650 Identifying a key person If a key person dies or is unable to work for an extended period of time due to illness or injury, the profitability and ongoing viability of a business could be at risk. A key person is someone whose inability to work is likely to result in reduced revenue coming into the business. This may be an owner but may also be a key employee. Key person insurance is an insurance policy taken out by a company on an employee. The company is the policy owner and the employee is the life insured. A business plan should identify key employees and the business impact if that person was unable to work.

¶7-660 Benefits of a key person insurance policy Insurance policies could be taken out to cover death, total and permanent disability and/or trauma for the key person. These policies would pay a lump sum that can then be used to: • pay expenses to hire a replacement • replace revenue generated by that person to maintain business solvency • repay a loan owed to the key person or external lender (can also help to maintain credit ratings) • compensate owners for a fall in business value (due to loss or revenue or goodwill) • help transition the business to new owners. Considerations to determine need and cover amount There are a range of factors to consider when determining whether a business needs key person insurance and what protection needs to be put in place. Questions that a business owner may wish to consider include: • What would be the direct and indirect costs of replacing the employee? This should include recruitment and training costs. It may also require an increase in salary if the person has been a long-term employee or an owner who is not on full market rates.

• What would be the potential reduction in profit that the business might experience following the event? This includes loss of customers, loss of productivity and loss of goodwill. • How long would it take to get someone else up to speed on the role to generate the same level of profitability and what working capital is required to cover this period? It may be difficult to put a value on some of these items, but business owners should try to estimate the costs to determine how much cover is appropriate. If taxation is payable on the claim proceeds, the level of cover could be increased to allow for tax payable. Insurance companies often have budget tools or guidelines to help a business owner map out this process, so assistance could be sought from the life insurance company, particularly as the company’s underwriters may want to validate the reasonableness of the cover requested. The costs may be estimated as actual dollar amounts. Alternatively, various rules of thumb could be applied to determine the loss impact that the key person will have. For example, a multiplier factor (Key Person Factor — KPF) may be applied to the person based on their overall contribution to the business. This is then used within one of the following formulae: • Revenue rule: Current sales revenue × KPF • Profit rule: Uplift profit (gross or net) by a factor of 2 of 3 × KPF • Liability rule: Liabilities × KPF • Remuneration: Uplift remuneration of key person by a factor (up to 10) × KPF.

¶7-670 Structuring key person policies With business insurance, it is always important to consider whose bank account the money should go into to cover expenses and losses as that can be the starting point for determining the policy owner (although other factors are also important). For a key person policy this should be the employer so that claim proceeds are paid directly to the employer. If the business is run as a sole trader, the policy owner would be the person running the business. If the life insured is the business owner, this is effectively the same as a personal insurance policy as the business technically ceases on the death of the sole trader. Partners will generally own the policy in joint names rather than in the name of the partnership because like a sole trader, a partnership is not a legal entity that can own assets. If partners are likely to change frequently, the partnership may use an administration company or a trust to own the policy. This may help to minimise issues with CGT. If the business is a company the policy should be owned by that entity to cover the life of an employee particularly if it is for a revenue purpose. If it is a company with only one shareholder and the policy is held for capital purpose, the policy could alternatively be held in the name of that shareholder. For a business run through a trust, the trustee of the trust should be the policy owner.

¶7-680 Tax implications for key person The company or business is the policy owner and pays the premiums. Whether the premiums are deductible as business expenses will depend on the purpose for the policy. This was outlined in Income Tax Ruling IT 155. Identifying the purpose The purpose of the insurance cover is either attributed to: • a revenue purpose — such as replacement of lost income or compensation for lost profits. These are items that normally affect the profit and loss statement of the business, or

• a capital purpose — such as repayment of debts or compensation for loss of goodwill. These are items that normally affect the balance sheet of the business. The proceeds of the revenue portion of the policy are assessable as taxable income and that portion of the insurance premium is tax deductible. However, the proceeds of the policy which are attributable to the capital portion of the policy are generally not tax assessable and the premiums are also usually not tax deductible. If the claim was paid for total and permanent disability or trauma, capital gains tax would be applied to the claim proceeds. The business should pass a resolution or keep a written record of the purpose and intent for the insurance policy. If the ATO conducts an audit they will consider not only the stated purpose but also how the proceeds were used. The amount of the cover should show a close relationship to the loss that is expected to be incurred. Over time the purpose can change. Proceeds that may have been expected to be tax-free at commencement of a policy may in fact become taxable at the time of the claim payment. If insurance cover is needed for both income and revenue purposes it is possible to hold one policy and show the split in written records, but it may be better to hold two separate policies. Taxation of premiums and claim proceeds The tax implications can be summarised in the table below. Are premiums a deductible expense?

Are claim proceeds Does CGT apply to assessable income for claim proceeds? tax?

Cover for death Revenue purpose

Yes. Term life premiums Yes are deductible

Yes, but only if the recipient is not the original owner and did not pay any consideration for transfer of ownership.

Capital purpose

No

No

No

Cover for TPD or trauma events Revenue purpose

Yes

Yes

Yes, if the recipient is not the life insured or a defined relative of the life insured. Any amount included as assessable income will reduce the capital gain.

Capital purpose

No

No

Yes, if the recipient is not the life insured or a defined relative of the life insured.

A defined relative includes a current spouse (either married or de facto), parent, grandparent, brother, sister, uncle, aunt, nephew, niece, child (including adopted or step), or a spouse of any one of these relatives. The ATO does not recognise an employee as a key person for revenue purposes if their death or disablement is likely to result in the business closing, for example a sole trader. Capital gains tax implications from claims

Capital gains tax may apply to the claim proceeds from an insurance policy used for key person purposes if: • the beneficial ownership has changed, and • some consideration was given for the transfer of the policy. The consideration does not need to be monetary. For example, it could be a restraint of trade promise. CGT can also apply if the policy was a TPD/trauma policy, and proceeds are paid to someone other than the life insured or a defined relative. If CGT applies, the taxable gain is the difference between the claim proceeds and the consideration paid (cost base). The 50% discount (applicable to assets held for more than 12 months) is unlikely to apply. The CGT asset is the right to make a claim against the policy, therefore the “acquisition” date is deemed to be the date that the trigger event occurs (ie the death or disability diagnosis) or the date the claim is lodged and accepted. If the claim is paid within 12 months of this date, the full proceeds are assessable for CGT purposes. Accounting records Term insurance policies do not have any cash value so they will not appear on the business balance sheet but may be referred to in the accounts. The premiums are recorded as an expense even if not tax deductible.

¶7-690 Case study — key person Alan and Alice are business partners operating under a company structure. Alan runs the sales and client relationships and the business relies heavily on his reputation. They have a $100,000 loan with the bank which is secured by personal guarantees from them both. They estimate that if Alan were to pass away or be unable to work, the following expenses would be incurred: • recruitment and training of replacement — $90,000 • revenue reduction over first year — $240,000. Alan and Alice sought advice and a recommendation was made to obtain key person insurance for death and TPD on Alan’s life. The amount recommended was $430,000. This provides a lump sum to repay the debt (to reduce pressure on cashflow), pay expenses and cover the revenue reduction. The insurance policy has two purposes — $100,000 capital and $330,000 revenue. The cover could be taken as one policy, but the premium would need to be apportioned between deductible and non-deductible components. The premiums on the revenue portion (ie $330,000 / $430,000 = 76.74%) are tax deductible. To claim a deduction the policy should be held in the company name as policy owner. If a claim is paid, the $330,000 revenue portion (if still used for that purpose) would be taxable income to the company. The $100,000 capital portion is tax-free if paid on Alan’s death but would be subject to CGT if a TPD claim is paid. The $330,000 revenue portion is also subject to CGT but as it would already form taxable income the CGT liability is reduced to nil on that portion.

BUSINESS SUCCESSION PLANNING ¶7-700 Overview of business succession planning If a business is owned by more than one person, consideration needs to be given to what happens if one of the owners dies or is unable to work for any period of time due to illness or injury. This may trigger a need for that owner to exit the business and to facilitate a smooth transition to the remaining owners. In these cases it is important for the owners to have in place a business succession plan that can achieve two outcomes: • avoid disputes between partners and/or their families, and • provide the continuing business owners the opportunity and means to gain full control of the business without significant financial stress.

Tip Under partnership law, a partnership is dissolved upon the death of a partner. The business can only continue if the deceased partner’s beneficiaries agree. Having a binding agreement in place to enforce this agreement without disputes would be important.

Example No buy/sell in place Brynne and Gabi are equal shareholders in High Fashions Pty Ltd which is estimated to be worth $4m. Gabi dies suddenly from a heart attack. Unfortunately, they did not have any business succession plans in place. Gabi’s husband Jeffrey inherits all Gabi’s assets. He is willing to sell his share of the business but Brynne does not have the capital needed to fund the purchase. Jeffrey also feels the business is worth a lot more than Brynne believes it is worth. This is causing some tension and the business is suffering as focus is taken off the day-to-day operations. Brynne may be faced with the following choices: • accept Jeffrey as her new business partner even though they do not get along and Jeffrey does not have the skills needed • sell the whole business or just Jeffrey’s share to an external party — which may result in a need to sell for less than true market value and if she is continuing, she will need to work with a new partner • take on debt to finance the purchase from Jeffrey • negotiate with Jeffrey to agree to a deferred payment plan spread over a number of years. If Brynne and Gabi had put a buy/sell agreement in place with an agreed valuation method and an insurance policy on Gabi’s life that was structured to cover the cost for Brynne to purchase Gabi’s half, better outcomes may have been created for all parties.

¶7-710 The components of a buy/sell plan A buy/sell plan needs two components to be fully effective. It is important that both components are considered together and are structured accordingly. The buy/sell agreement should match the business structure and the funding agreement should ensure the correct cash flows. Contractual agreement The first component is a contractual agreement (the buy/sell agreement) which sets out the terms and conditions for the business succession if one partner is unable to fulfil duties due to death, illness or injury. It may also include details for other events such as retirement or resignation. This agreement should include details for how the business is to be valued, the departure events to be included and the procedures to follow if such an event occurs. The legal construction of the agreement normally includes put and call options to force the transfer. The continuing owner can use the call option to force the departing owner to sell. The departing owner (or estate) can use the put option to force the continuing owner to buy. Funding mechanism The second component is a funding mechanism which provides the capital to allow the remaining owners to buy the departing owner’s share. This is usually covered by an insurance policy on that departing owner’s life if the departure is caused by death, illness or injury. If insurance is not put in place the continuing owners would need to fund the purchase from their own savings or borrowing. Alternatively, they may need to accept a new partner into the business to inject new capital. The arrangement and level of insurance should be reviewed on a regular basis to check that it stays in line with the business valuation.

¶7-720 Structuring buy/sell insurance

Self-ownership Each business owner takes out a life insurance policy for the required events on their own life. The life insured is also the policy owner. The premiums are generally paid by the business. If the insured event occurs, the claim proceeds will be paid to the policy holder or their estate. This is taken to be full or partial payment for their share of the business depending on the valuation applied and the amount of the insurance proceeds. Ownership is relinquished to the remaining owners. This option is the most simplistic and avoids CGT issues (¶7-760) but will only be effective if a wellconstructed and valid buy/sell agreement is in place to match this approach. Example Paul and Susan are equal partners in a business which is operated through a company structure. Paul passes away suddenly. Luckily, they had sought advice and put in place a buy/sell agreement with a life insurance funding mechanism. When the agreement was set up, they agreed to value the business using the industry standard of two times the annual sales revenue. This put a $3.2m value on the business. Paul and Susan both took out life insurance policies for death and TPD for their share of the business at $1.6m. The policies were set up under self-ownership so they each own the policy on their own life. The premiums have been paid by the company. Since the agreement was put in place the business has grown and the business is now valued at $4m. With Paul’s death the buy/sell agreement becomes effective and Susan exercises her option to buy his share of the business for $2m. Paul’s estate has received $1.6m from the insurance policy as part payment for the transfer under the agreement. Susan just needs to pay a further $400,000 to purchase his share of the business. Paul’s estate will not pay tax on the insurance proceeds received. But he is deemed to have sold his share of the business for $2m and normal business CGT rules apply.

Cross-ownership The business owners are the policy holders of insurance policies on the life of the other owner. The premiums are generally paid by the business. If the insured event occurs, the claim proceeds will be paid to the policy holder (ie the continuing owners). This money can then be used to help fund the purchase of the departing owner’s share of the business on terms as outlined under the agreement. This option can assist each party to have a bargaining position (particularly if the buy/sell agreement has been poorly drafted) as the continuing owners are holding the cash and the departing owner (or estate) is holding a share of the business. Each has an incentive to trade with the other. But on the downside, cross-ownership creates CGT issues if the event is caused by total and permanent disability or trauma (¶7-760) so it is a less common option. An opinion issued by the ATO in November 2014 confirmed that the new super regulations which came into effect from 1 July 2014 do not allow cross-member strategies where insurance is to be held through superannuation (¶7-870). Example Using the example above, if Paul and Susan had structured the insurance policies under a cross-ownership structure Susan would have owned the insurance policy on Paul’s life. Upon Paul’s death, Susan is able to exercise her option under the agreement to buy his share of the business for $2m. She receives $1.6m from the insurance policy and will need to find the additional $400,000 to fund the business share purchase. Susan pays Paul’s estate $2m and the estate transfers his share of the business to her. Paul is deemed to have sold his share of the business for $2m and normal business CGT rules apply on this sale. If the buy/sell transaction was triggered by Paul’s permanent disability rather than death, Susan would have triggered a CGT liability on the claim proceeds received unless she is a defined family member (¶7-760). This would have meant that she would need to find the resources to fund the CGT as well as pay the additional $400,000 for the business share purchase.

Company ownership If the business is operated through a company structure, that company could own a life insurance policy

on the life of each business owner. The company pays the premiums. If the insured event occurs, the claim proceeds are paid to the company. The buy/sell agreement then operates to allow the company to buy back the departing owner’s shares using the insurance proceeds and other funds as required. These shares are then cancelled so that the remaining shareholders now have full ownership. Example Using the example above, if Paul and Susan had structured the business as a company and the company owned the insurance policies the company would have owned the insurance policy on Paul’s life. Upon Paul’s death, the company exercises its obligation to buy back Paul’s shares. The company receives $1.6m from the insurance policy and borrows another $400,000 (or uses cash reserves) to fund the buy back. Paul’s shares are cancelled and Susan becomes the sole shareholder. Susan’s shares are now worth twice the amount they were previously but there is no adjustment to the cost base so she may face increased CGT issues in the future when her shares are disposed of. Paul is deemed to have sold his share of the business for $2m and normal business CGT rules apply.

Discretionary (bare) trust ownership A trust is set up for the sole purpose of facilitating the succession plan. The trust owns a life insurance policy on the life of each business owner. The business generally pays the premiums. If the insured event occurs, the claim proceeds are paid to the trust. The trustee then distributes the funds according to a distribution schedule which matches to the process required under the buy/sell agreement. The trust should be set up as a bare trust. For CGT outcomes (¶7-760), the distribution schedule may create a different outcome if the event is death than if the event is disability or critical illness. Superannuation fund ownership Clients setting up buy/sell arrangements should be advised against purchasing insurance to fund buy/sell agreements inside superannuation. Whether the insurance can be held inside superannuation had long been a contentious issue with debate as to whether it breached the sole purpose test. The ATO entered into the debate by issuing ATO Interpretative Decision (ATO ID 2015/10) which considered a situation within an SMSF. The ATO view is that a life insurance policy held inside an SMSF breaches the sole purpose test if the purchase is a “condition and consequence” of a buy/sell agreement. Depending on the circumstances the arrangement may also breach the restriction on providing financial assistance to a relative of a fund member. Despite the non-binding nature of an Interpretative Decision, it is now generally accepted by the industry that funding a buy/sell agreement using insurance inside an SMSF is not allowed and the principles may be applied to all superannuation funds. The details in ATO ID 2015/10 A member of an SMSF (the member) and his brother ran a business through a company in which they were the only two shareholders (the company). The SMSF’s only other member is the member’s spouse. The member and his brother entered into a buy/sell agreement where: • the SMSF purchased a life insurance policy on the member’s life for the agreed market value of the member’s interest in the company • the company agreed to pay the life insurance premiums by making contributions to the SMSF, and • upon death of the member, the member’s shareholding in the company would be transferred to his brother. The member’s spouse would receive the deceased member’s superannuation and insurance benefits in exchange.

The ATO view The ATO determined that the sole purpose test was breached because the decision to purchase the life insurance policy was influenced by other factors that were not related to providing retirement or death benefits for the member or his dependants. The factors that support the ATO’s decision include: • the calculation of the insured amount is not based on the future needs of the member’s spouse, but is based on a valuation of the member’s share of the company • although the member’s spouse receives a death benefit payment from the SMSF, the true benefit is that a non-member obtains 100% ownership in the relevant company, and • the ATO argued that the company contributions to fund the premiums were never intended to produce a retirement benefit, but rather, the purpose was to provide liquidity for business succession purposes. The ATO also concluded that the terms of the agreement are seen as providing financial assistance to the member’s brother. This is because the resources of the fund are used to allow the member’s brother to obtain total ownership and control of the company upon the member’s death. The ATO ID did not address grandfathering arrangements for any buy/sell agreements held inside superannuation before this ID was issued. The ownership decision Choosing the ownership structure for the life insurance policy is a matter of transactional control as well as tax effectiveness. It is important to ensure that the money ends up in the hands of the departing owner or estate and the ownership of the business ends up in the hands of the continuing owners. This should be the first consideration, with taxation effectiveness being second. When making a decision on which ownership option to recommend, consideration should be given to: • the current business structure and the potential for future changes • how premiums will be paid and mechanisms to avoid lapses • taxation implications, especially CGT on disability and trauma claims. A summary of key points to consider is outlined in the table below. The tax implications are discussed at ¶7-760. Policy ownership option

May be suitable if:

Disadvantages

Tax on claim proceeds

Self-ownership

– life insured wants control over the policy

– other business owners – death — no CGT* need to ensure the premiums do not lapse

– covering TPD/trauma events

– if buy/sell agreement – TPD/trauma — no is not structured CGT correctly the departing owner ends up with cash and share of business but with good advice this can be avoided

– business ownership is likely to change in future Cross-ownership

– small business that is – may incur CGT for unlikely to have frequent trauma/TPD

– death — no CGT*

changes in ownership – business partners are family members

– if business partners change, policies need to be adjusted and may create CGT issues for death claims

– TPD/trauma — CGT applies unless policy owner is a defined relative^

– life insured does not have control over the policy Company ownership

– business has large number of owners

– the share values increase for continuing owners but no – business ownership is corresponding increase likely to change in future in cost base which increases CGT upon disposal

– death — no CGT* – TPD/trauma — CGT applies

Trust ownership

– use one insurance policy for several purposes

– if life insured leaves the business a reassignment of the policy may create CGT issues for death claims

– trust deed can be structured to distribute claim proceeds to avoid CGT (Tax Determination TD 94/31)

– business has large number of owners

– may incur extra cost and complexity

– business ownership is likely to change * CGT is not payable if the policy owner is the original owner, or if not, did not pay any consideration for taking over ownership. ^ A defined relative includes a current spouse (either married or de facto), parent, grandparent, brother, sister, uncle, aunt, nephew, niece, child (including adopted or step), or a spouse of any one of these relatives.

¶7-760 Tax implications for buy/sell arrangements Using insurance to fund a buy/sell agreement has a capital purpose. Therefore the premiums are generally not tax deductible. This also means that the claim proceeds are not taxable as income, however, CGT may apply depending on the circumstances. CGT implications for claim proceeds Capital gains tax may apply to the claim proceeds from an insurance policy used for business succession purposes if: • the beneficial ownership has changed, and • some consideration was given for the transfer of the policy. The consideration does not need to be monetary. For example, it could be a restraint of trade promise. CGT can also apply if it was a TPD/trauma policy and proceeds are paid to someone other than the life insured or a defined relative.

Tip

A defined relative includes a current spouse (either married or de facto), parent, grandparent, brother, sister, uncle, aunt, nephew, niece, child (including adopted or step), or a spouse of any one of these relatives.

If CGT applies the taxable gain is the difference between the claim proceeds and the consideration paid (cost base). The 50% discount (applicable to assets held for more than 12 months) is unlikely to apply. The CGT asset is the right to make a claim against the policy, therefore the “acquisition” date is deemed to be the date that the trigger event occurs (ie the death or disability diagnosis) or the date the claim is lodged and accepted. If the claim is paid within 12 months of this date, the full proceeds are assessable for CGT purposes. CGT implications for transfer of business share The departing owner is disposing of their share of the business. This triggers a CGT event. The cost base is determined under normal rules and the sale price is the amount of the proceeds received for the transfer or market value (the higher of). The tax payable may be reduced by using eligible small business CGT concessions and the CGT discount where applicable. It should be noted that the legal structure of the buy/sell agreement is important. If the agreement uses put and call options to give both parties the right (but not binding obligation) to enforce the transfer, the effective disposal date for the business is the date of transfer. However, if other methods are used to make the sale a binding obligation on both parties the sale date could be the date that the buy/sell agreement is signed. This is why put and call options are most commonly used.

LIFE INSURANCE INSIDE SUPERANNUATION ¶7-800 Overview of insurance inside superannuation Insurance can be held inside superannuation but only if it does not breach the sole purpose test or other SIS provisions. The strategies for using insurance inside superannuation have changed in years since 2014 due to the issuance of ATO views and rulings. Clarification has been provided by the ATO on what types of insurance can be held inside superannuation and what strategic purposes are allowable. These changes particularly affect disability policies. Since 1 July 2014 any new insurance policy commenced inside superannuation must have a claim definition that matches the conditions of release for death, terminal medical condition, permanent incapacity or temporary incapacity (SISR reg 4.07D). This means only the following types of insurance cover can now be commenced inside superannuation: • death cover • total and permanent disability (any occupation definition) • income protection (often referred to as salary continuation). Where applicable, the insurance can be added to a policy that has accumulated savings or can be held as a stand-alone insurance only superannuation policy (but not if just total and permanent disability).

Tip Advisers may come across clients who have held TPD policies with an “own occupation” definition or trauma policies inside superannuation. Provided these policies were commenced before 1 July 2014 they can continue to be held inside superannuation but new policies cannot be commenced.

Changes cannot be made to these policies nor can they be transferred to another fund. These types of policies created both potential problems with preservation and access to claim benefits. The claim is paid by the life insurance company to the superannuation fund if the insurance definition is met, but the member cannot access the benefits unless a superannuation condition of release is met. This created the potential for the claim benefits to be trapped inside superannuation and not be available for the intended purpose.

Example Alex, age 48, runs his own dental practice. He is diagnosed with a skin disorder that will prevent him from operating as a dentist. This triggers payment under his TPD own occupation policy which was commenced inside superannuation before 1 July 2014. The claim proceeds are paid to the superannuation fund trustee (as policy owner) and added to his member account balance. However, as he is able to continue work as a consultant or lecturer (with previous experience), he does not meet the incapacity definition to release benefits from superannuation. The money is preserved in his superannuation fund and is not available to fulfil the purpose intended. If Alex was looking to commence a new TPD policy inside his superannuation fund today, he would be limited to a policy with an “any occupation” definition.

¶7-810 The structure of insurance inside superannuation If insurance is taken out inside superannuation, the trustee is the policy owner and the member of the fund is the life insured. Responsibility for the payment of premiums belongs to the superannuation fund trustee. These payments are deducted from the member’s account balance. In the event of a claim, the superannuation fund, as the policy owner, receives the proceeds. The money is added to the member’s account and becomes part of the member’s superannuation savings. The member needs to meet a condition of release to access the benefits and taxation applies under superannuation payment rules (¶4-420). Example Kyle is a member of a superannuation fund and has elected to take insurance through his fund to cover both death and TPD (any occupation). The trustee sets up an appropriate policy. This is not a group policy (¶7-930) so Kyle needs to undergo a full underwriting process. The cover is approved for a premium of $2,000 per annum. The policy is held in the name of the superannuation trustee as policy owner with Kyle as life insured. The premiums are deducted from Kyle’s account balance. Kyle suffers a major stroke and is unable to work again. A claim is submitted against the life insurance policy and is approved. The claim proceeds are paid to the superannuation fund trustee and then added to Kyle’s account balance. Kyle applies to the trustee for a release under the permanent incapacity condition of release. This is approved and a lump sum is paid to Kyle. He is under age 60 so lump sum tax applies.

Tip A person who is unhappy with a trustee decision of an APRA regulated superannuation fund can apply to the Australian Financial Complaints Authority (replaced the Superannuation Complaints Tribunal from 1 November 2018) (¶8-615) to have the decision reviewed. This can include decisions by the trustee that the member does not meet the permanent incapacity condition of release.

¶7-820 The advantages and disadvantages of insurance inside superannuation for non-business reasons

Funding insurance through superannuation can provide strategic opportunities for clients when looking at personal (non-business) needs and may help with access and affordability. However, there are also pitfalls due to the impact of superannuation rules, so it is important to determine whether superannuation is the most appropriate structure to hold insurance. The benefits of holding insurance inside superannuation mostly occur at the time of paying the premium, to make the cover more accessible and/or affordable. However, the disadvantages are most likely to occur at the time the benefits are paid. Advice recommendations should weigh up the advantages and disadvantages and these should be clearly explained in the Statement of Advice. The following table provides a comparison of the main issues to consider when assessing the advantages and disadvantages of each option. Superannuation

Non-superannuation

Cashflow

Premiums can be funded from Clients need to fund the full cost of employer contributions (including premiums from disposable superannuation guarantee) or from cashflow, using after-tax dollars. pre-tax dollars using salary sacrifice or personal deductible contributions. This can assist with managing cashflow and reduce the effective cost. (¶7-840).

Taxation deductions for premiums

The premiums are deductible to the fund trustee (except trauma policies) which may reduce the effective cost of insurance.

Deductions can only be claimed for premiums on income protection policies and some business policies.

Payment options

Once accessible, claims may be paid as a lump sum or in some cases, can be paid as a pension. The option may also exist in some situations to retain the benefits inside superannuation.

Claims are paid as lump sums, except income protection which is paid as a series of income payments.

Receiving benefits

Claim proceeds can only be accessed if a superannuation condition of release is met (¶4440).

Claim proceeds can be accessed once the insurance definition is met and the claim is paid.

Access is less likely to be a problem now that TPD own occupation and trauma policies cannot be purchased inside superannuation (¶7-800). The time it takes to access benefits is likely to be longer due to the additional processing requirements for superannuation withdrawals and trustee approval. Cost of cover

Clients may have access to group Clients need to be fully policies (¶7-930) through underwritten and bear any employment arrangements without outcomes. medical underwriting. This may provide a cheaper premium and easier application process, particularly for clients with medical

issues that may otherwise incur loadings, restrictions or nonacceptance. Beneficiaries

Superannuation legislation restricts Full flexibility to nominate anyone who can be the beneficiary of a as beneficiary. Policy owner does death benefit (¶4-425). Only the life not have to be life insured. insured can be the recipient of a disability policy.

Taxation of benefits

Benefits are taxed under superannuation rules, so tax may apply if the person is under age 60 or if a death benefit is paid to a non-tax dependent (¶4-425).

Policy cancellation

The policy only continues while the The policy continues as long as person is a member of the premiums are paid or until the superannuation fund. policy expiry age.

Retirement impact

Paying premiums from account balance reduces the accumulation of retirement savings.

Paying premiums reduces disposable income that may otherwise be saved to accumulate a retirement benefit.

Policy benefits

The range of features and benefits available on a policy may be limited due to the requirements of the sole purpose test.

No restrictions on features and benefits that can be made available.

Benefits are generally paid tax-free unless: – Income protection — taxed at marginal tax rate. – Some business policies — may be classified as taxable income or be subject to capital gains tax. – The policy owner is not the original owner and paid some consideration for the transfer — CGT applies.

¶7-830 Meeting the sole purpose test The sole purpose test (under s 62 of the Superannuation Industry Supervision Act (SISA)) restricts how superannuation savings can be used or invested. All benefits must be held for the core purposes of retirement or providing for beneficiaries upon the member’s death, but can also (but not solely) be held for an ancillary purpose of providing disability benefits. Any concerns in relation to the sole purpose test have primarily related to disability policies (TPD, income protection and trauma insurance). Disability benefits are ancillary benefits and the definitions for claims and payment of some features did not necessarily meet the SIS definitions for a condition of release. For new policies since 1 July 2014, a TPD policy can only be commenced inside superannuation if it has a claim definition that matches the SIS condition of release (basically any occupation definition) and the same applies for income protection (salary continuation) policies. Trauma policies can no longer be commenced inside superannuation. Trauma and TPD own occupation policies that commenced before 1 July 2014 can continue to be held in the superannuation fund. Even if insurance policies can be held inside superannuation, trustees are still advised to ensure that the sole purpose test is not breached. For example, as disability is only an ancillary purpose, using a significant portion of annual premiums to fund these policies may breach the sole purpose test as the fund may not meet the requirement to maintain benefits for at least one core purpose.

Tip The sole purpose test means that a stand-alone TPD policy cannot be the only investment held by a superannuation fund. Care must also be taken with death policies that include TPD at a higher level of cover than the death component. Advisers should check features and payment conditions of income protection policies carefully and compare these to equivalent non-superannuation policies.

¶7-840 Funding premiums inside superannuation Holding an allowable insurance policy inside superannuation can help a client with affordability to pay premiums. Using contribution strategies to fund the premiums can reduce the effective cost and also minimise the impact on the client’s disposable income. Managing cashflow Premiums for insurance policies inside superannuation can be deducted from a person’s accumulated account balance. This can be an effective strategy if the client has limited disposable income that they are able to direct towards the payment of premiums. The disadvantage is that they are reducing accumulated savings and will have less of a nest egg when they retire but it may be the difference between being able to afford insurance or not. Similarly, the client may be able to use the superannuation guarantee payments paid by their employer to fund the premiums. Example Clive is the sole breadwinner for his family and is keen to secure the family’s financial position if he dies or becomes disabled. However, with a young family and a large mortgage his budget is already strained. He is not sure how he could afford the extra expense of insurance cover. Clive has a superannuation balance of $130,000 and his employer is paying $630 per month as Superannuation Guarantee contributions into his account. Clive seeks advice and after weighing up all the advantages and disadvantages he decides to take out life and TPD cover inside his superannuation fund. The total premiums are $3,600 per year. The SG contributions will more than adequately cover the premiums and also allow his account balance to keep growing for his retirement. In future, Clive may be in a financial position to top-up his contributions to restore his superannuation balance or minimise the decline in its growth.

Contribution strategies Ideally, if insurance is to be held inside superannuation, clients should make additional contributions into their fund to pay the premiums. In this way, they are not trading off their future retirement savings for insurance cover today. If the contributions are made through either salary sacrifice or personal deductible contributions to super this may reduce the effective cost of the premiums as they are paying the premiums from pre-tax dollars. If the trustee of the superannuation fund is able to claim a tax deduction for premiums (¶7-850) and passes on this deduction to the member of the fund, the premiums are paid from tax-free income. This may be cheaper than paying the premiums from after-tax income outside of superannuation. It should be noted that amounts that can be contributed under both the concessional contributions cap and the non-concessional contributions cap were significantly reduced from 1 July 2017. This limits a client’s ability to save for retirement using superannuation. If some of these caps are used to make contributions to then pay insurance premiums, the savings ability is limited further. Clients should consider the trade-off. Example

Clive receives a large promotion and decides that he can now afford to pay the premiums for his insurance cover from his own resources so he no longer diminishes his superannuation savings. He decides it is still most appropriate to hold the cover inside superannuation and arranges with his employer to salary sacrifice into his superannuation fund to cover his insurance premiums. His employer agrees to contribute an additional $3,600 into Clive’s superannuation under a salary sacrifice arrangement. The trustee is able to claim a tax deduction for the premiums and passes this benefit on to Clive. The contributions tax otherwise payable on his salary sacrifice contributions is reduced to nil. The full $3,600 is available to pay the insurance premiums. If Clive were to pay these premiums outside superannuation, on a 39% tax bracket (including Medicare) he would need to earn $5,902 to have $3,600 after tax. This strategy has saved Clive $1,404 in tax. The tax saving is calculated as:

Tax without strategy = $5,902 ×  39% Tax on $2,302 salary ($5,902 − $3,600) = $2,302 ×  39% Tax saving = $2,302 −  $898

= $2,302 = $898 = $1,404

When recommending contribution strategies using salary sacrifice (¶4-215) or personal deductible contributions (¶4-220) it is important to understand the accounting procedures used by the superannuation fund (¶4-320) to determine how tax effective the strategy is. The tax liability for the superannuation fund (including tax on earnings and concessional contributions) is paid by the trustee on the fund as a whole. When accounting for tax deductions on premiums trustees may: • apply the deduction to a specific member’s account so that member benefits fully from the deduction on their premiums, or • spread the deduction across all members of the fund or all members in a particular class of the fund. In these situations the trustee deducts the 15% contributions tax from all concessional contributions regardless of insurance premiums paid. The tax deduction for the premiums is then used to boost the fund’s effective earnings rate.

¶7-850 Tax deductions for premiums in superannuation Premiums for insurance policies held inside superannuation are fully tax deductible to the fund trustee for the following policies: • life insurance (death cover) • income protection • total and permanent disability any occupation definition. If the policies are held for TPD with an own occupation or other modified definition (¶7-210) the premium may only be partially tax deductible to the trustee. Only policies commenced before 1 July 2014 may have these definitions (¶7-830). Since 1 July 2011, the tax deduction has only been allowed to the trustee if the payment relates to a current or contingent liability by the fund to provide a disability superannuation benefit. For the pre 1 July 2014 policies where the policy definition differs to the SIS condition of release (¶4-420) the premiums may only be partially deductible based on the proportion of the premium for which it is determined that a disability benefit is likely and able to be released under the permanent incapacity release condition (¶4320). This can be determined by an actuary or the following proportions can be used: • 100% of premium for an any occupation policy

• 67% for TPD own occupation if held stand-alone • 80% if bundled with a life policy.

Tip The premiums for insurance policies held outside superannuation are not tax deductible unless it is an income protection policy, or a policy held on revenue account by a business (¶7-680). The premiums for trauma policies held inside superannuation have never been tax deductible.

¶7-860 Taxation of insurance through superannuation Proceeds of a life insurance policy paid through superannuation are paid to the trustee of the superannuation fund as the policy owner. No tax is payable at this point. The insurance proceeds are generally added to the member’s account and become part of the superannuation account balance. Any benefits subsequently paid out of the superannuation fund will be taxed under superannuation benefit taxation rules (¶4-420 and ¶4-425). This section considers some of the specific taxation implications to consider when deciding whether to hold insurance inside superannuation. Death cover Death benefits paid from superannuation are tax-free if paid to a tax dependent, but if paid to a non-tax dependent, lump sum tax is payable on the taxable component of the death benefit (¶4-425). If a lump sum death benefit includes an insurance payout the taxable component is split into taxed and untaxed elements. This can result in lump sum tax rates up to 30% plus Medicare. The untaxed element is not included if the death benefit if paid as a pension to an eligible dependant (¶4425). If either the deceased fund member or the dependants are over age 60 the income payments are tax-free. If both are under age 60, the taxable component is included as assessable income for the dependant but a 15% tax offset will apply. Terminal illness payment If the life insurance policy pays a terminal illness payment (¶7-100) it will only be released from superannuation if the terminal illness condition of release is met (¶4-400). Under this condition of release, the benefits must be paid to the member as a lump sum and are paid tax-free. If not released to the member, normal death benefits tax applies when paid to a dependant upon death (¶4-425). TPD benefits The trustee can pay the benefit, either as a lump sum or a disability pension if the permanent incapacity condition of release is met (¶4-400). The benefit is split into tax-free and taxable components. The tax-free component can be increased due to the operation of s 307-145 of the Income Tax Assessment Act 1977 if a disability benefit is paid. The taxable component does not include an untaxed element. The standard superannuation lump sum taxation rules apply (¶4-420). If paid as a pension to a person under age 60 a 15% tax offset applies to the taxable component. Salary continuation (income protection) Income protection benefits inside superannuation can only be paid to the person for the period of incapacity as a non-commutable income stream under the temporary incapacity condition of release. No tax concessions apply to these payments, even if the person is over age 60. The income paid is fully taxable at the person’s marginal tax rates. PAYG tax deductions will be deducted by the fund trustee from

each income payment.

¶7-870 Cross-insurance and self managed superannuation funds Cross-insurance strategies were being used to protect limited recourse borrowing arrangements (LRBAs). However, information on the Q&A section of the ATO website posted on 17 November 2014 confirms that regulations (effective from 1 July 2014) do not allow cross-insurance when held through superannuation. The basis for the ATO view is a clause in the Explanatory Memorandum which introduced the new SIS Regulations effective from July 2014, stating that proceeds of an insurance policy must be released to the insured member. Using cross-insurance Previously, cross-insurance had been used where an SMSF entered into an LRBA to acquire a lumpy asset (such as business real property) and the fund members were business partners, or to fund buy/sell agreements. Under this arrangement, the fund took out insurance policies on the lives of each member under a crossinsurance arrangement with premiums for each policy deducted from the account of the non-insured member. When one member suffered an insured event (ie died or became TPD), the proceeds were credited to the surviving member(s) account. This allowed liquidity risk to be managed as the proceeds could be used to repay the debt and/or pay a death benefit without needing to sell the asset or be used to offset the sale price for a business transfer. The current ATO view The ATO has advised that cross-insurance for any new insurance products is not permitted as the insured benefit will not be consistent with a condition of release for the member receiving the benefit and so claim proceeds may be locked within superannuation. The ATO view is that this is in line with the changes that have applied since 1 July 2014 (¶7-800), and while it has been subject to industry debate, this view is now generally accepted across the industry.

Tip The disallowance of cross-ownership only applies to insurance policies commenced inside superannuation from 1 July 2014. Any policies commenced since that date under a cross-ownership strategy should be reviewed to ensure SIS rules have not been breached. This view was supported in ATO Interpretative Decision 2015/10.

¶7-880 Superannuation reserving strategies Reserves are generally built up from investment earnings. Instead of allocating the earnings to member accounts as investment returns, some of the earnings may be directed into a reserve account. These reserves may be held for purposes such as investment smoothing and payment of income streams. A superannuation fund can set up reserves (¶5-700) for various strategic purposes under s 115 of the SISA, unless prohibited by the trust deed. However, these strategies are increasingly coming under ATO scrutiny for SMSFs. In March 2018, the ATO issued SMSF Regulator’s Bulletin (SMSFRB 2018/1) stating its concerns with reserves in SMSFs and its view that a legitimate use of reserves will be limited. The ATO flagged its intention to review the use of reserves carefully with particular concerns that strategies are being used to circumvent the new rules relating to transfer balance caps and contribution limits. See also ¶5-700.

Caution If setting up or operating reserves within an SMSF caution should be taken to ensure the sole purpose test is not breached (¶5-320) and to consider all taxation implications, including the impact on concessional contributions caps. Strategy to provide liquidity for death benefits

Reserves have been used in conjunction with insurance to provide protection for the fund to retain lumpy assets such as business real property if a member suffers death or disability and needs to withdraw benefits from the fund. However, the ATO has expressed concern that these strategies may breach the sole purpose test under the new regulations that have applied since 1 July 2014. In the minutes of the Superannuation Industry Relationship Network (SIRN) meeting on 7 April 2016, the ATO expressed concerns that the insurance reserving strategy breached the sole purpose test using the same logic as applies to cross-insurance (¶7-870). This is based on the premise that the purpose of the insurance is not to increase the member’s benefit but instead is to protect assets of the fund. This view was reinforced in SMSFRB 2018/1. The basic elements of the strategy were as follows: • the superannuation fund is generally holding lumpy assets such as property • the trustee takes out a life and/or TPD policy on the life of members • the premiums are paid out of consolidated revenue or insurance reserve, not deducted from member accounts • the trust deed states that if the claim is paid, the funds are paid into a reserve instead of the insured member’s account • the trust deed included rules for entitlements to death and disability benefits. Example Note: This Example is provided to explain the strategy that was used; however, it may no longer be appropriate to use this strategy. George and Jerry are business partners and are both members of the same SMSF. The SMSF owns the factory that they lease to operate their business. The total fund balance is $2.4m and they each have equal balances of $1.2m. The factory is worth $1.6m and the other $800,000 is held in cash and listed shares. The concern is that if one passes away, and a death benefit needs to be paid out, that the SMSF may need to sell the factory to pay the death benefit. This could see the business close or at least experience financial difficulty for the remaining business partner. The SMSF trustee took out life insurance policies on both Jerry and George for $1.6m. The premiums were paid from consolidated revenue. The trust deed states that the death benefit payable is the greater of the account balance of the insurance claim. Jerry passes away. The $1.6m policy is paid to the trustee and added to the reserve account. Jerry’s death benefit is calculated at $1.6m as this is higher than his account balance at the time of $1.2m. The trustee uses the $1.6m cash received from the insurance policy to pay his death benefit and does not have to liquidate the investment property.

Given the ATO concerns in SMSFRB 2018/1 that this strategy breaches sole purpose test, extreme caution should be taken before implementing or continuing these strategies. An SMSFRB is not binding legislation but does indicate the ATO view and stance on regulating SMSFs. Self-insurance reserves SMSFRB 2018/1 also clarified the ATO’s view that an SMSF cannot self-insure through reserving strategies due to reg 4.07E of SIS Regulations. From 1 July 2016 a trustee of a regulated superannuation fund can only provide an insurance benefit to members if it is fully supported by an insurance policy provided by an insurance company. Therefore, an SMSF cannot maintain a self-insurance reserve.

¶7-890 Insurance in super and low-balance or inactive accounts The following measures have been implemented to avoid small superannuation balances being eroded by insurance premiums. Low-balance accounts From 1 April 2020, super funds can no longer offer insurance cover automatically to new members if

either: • the member is under age 25, or • the account balance is less than $6,000. These members will need to specifically opt in to any insurance cover in writing. If the employer is paying the full cost of insurance, automatic cover can be provided. Existing super members (as at 1 April 2020) with a balance below $6,000 would have had automatic insurance cover cancelled unless they opted in to keep the cover before 1 April 2020. Inactive accounts From 1 July 2019, if a superannuation fund is inactive (ie has not received any contributions or rollovers for 16 consecutive months), death or TPD cover will be cancelled unless the member specifically opts in to keep the cover or makes a contribution to keep the account active. This rule applies regardless of fund balance. The superannuation fund trustee is required to notify the member once the account has been inactive for nine, 12 or 15 months. This gives the member an opportunity to make a contribution or opt-in to retain cover. The new opt-in rules do not apply to defined benefit members or Australian Defence Force Super members. In addition, inactive superannuation accounts with balances of less than $6,000 will be closed and moved to a myGov superannuation account with the ATO. This would cause the cancellation of any attached insurance policies.

STEPPED VERSUS LEVEL PREMIUMS ¶7-900 Premium options for life insurance Premiums for life insurance policies can be set under two mechanisms: • stepped premiums, or • level premiums. Both options have advantages and disadvantages. Clients need to choose the premium option at commencement of the policy. They may be able to switch options at a later date but this will be less effective than choosing the appropriate option at commencement. Further paperwork may be required to make any switches.

¶7-905 Stepped premiums Many people select stepped premiums because the cost starts off lower than the level premium. Each year the premiums are increased according to a schedule of age-related premiums set by the life insurance company. This means clients can expect the cost of cover to increase each year. Stepped premiums can help to make life insurance more affordable at younger ages or in the early years of a policy. This premium option is usually more advantageous for clients who want to hold cover for the short term only (ie less than eight to 10 years) or who are on lower incomes at the time but expect to increase income over time.

¶7-910 Level premiums These premiums start at a higher level than stepped premiums but the premium payable at

commencement is fixed for life. The premiums do not increase over the life of the policy except to allow for any increases in cover or where premiums overall are indexed by the life insurance company. Level premiums can help to make life insurance more affordable on average over a longer period or at older ages. This option is usually more advantageous for clients who want to hold cover for the longer-term. It may allow clients to manage budgets more effectively as the cost of insurance going forward is known. Clients who have selected this option may also be less likely to cancel policies in later years as they will not face rising premiums.

GROUP INSURANCE COVER ¶7-930 What is group insurance? Employers may arrange an insurance policy to be offered to all employees or a group of employees under a single contract. This is often arranged inside a corporate superannuation fund. Benefits of a group insurance policy may include: • automatic acceptance up to specified cover without any medical underwriting which can make the cover cheaper and more accessible for people with health issues, or • group policy discounts on premiums. Group insurance may be provided for life, total and permanent disability and/or salary continuation options. The insured person will receive a certificate of cover instead of their own individual policy document. Cover commences and ceases at the time specified under the policy.

¶7-935 Benefits offered under group policies Group policies may provide cover for death, TPD and income protection. Under death and TPD cover, the benefit payable may be calculated using: • fixed multiples of salary • fixed sums insured • an age-based scale for determining the dollar amount insured • amounts of insurance connected to the superannuation account balance (for example, the insurance benefit may specify a dollar amount but the insurance component is reduced by the accumulated account balance). The maximum level of cover provided for death and TPD will depend on the individual insurer. TPD is generally paid as an advance on a death benefit (so reduces any associated life cover) and ceases at normal retirement age (generally age 65 unless an earlier age is specified in the employment contract). Group policies for income protection generally cover a percentage of pre-disability salary but instead of being paid directly to the life insured, claims are paid to the employer who then makes direct payments under the payroll system to the employee. Waiting periods and benefit payment periods will apply as selected by the employer.

¶7-940 Continuation option If a person leaves employment and is no longer eligible to continue as a member of the fund their insurance cover will cease although coverage may continue for a further 30 or 60 days.

If the policy has a rollover option, the person can apply to have their cover rolled over to a new individual policy without undergoing medical underwriting. This rollover option is generally only available if the person has commenced new employment within the continuation period.

¶7-950 Advantages and disadvantages of group policies Group life policies can be held both inside and outside of superannuation but is most commonly held within employer-sponsored corporate superannuation funds. Some of the main advantages and disadvantages of group policies compared to individual cover held in retail superannuation funds are outlined in the table below. Advantages

Disadvantages

No medical underwriting is required within autoacceptance limits.

Pre-existing conditions may be excluded, where cover can sometimes be provided in individual policies.

The employer may pay the premiums as part of the Levels of cover are pre-set and cannot be adjusted employment arrangement. to meet client specific needs. Benefits may not be automatically indexed. Cover ceases when employment ceases or the employer cancels the arrangement. If the person then needs to obtain their own cover they will face risks arising from the underwriting process. Cover generally ceases at a younger age than is available for retail cover. Income protection policies generally only provide a two- or five-year cover period, but payment to age 65 is possible (¶4-340). Income protection benefits may be offset by other benefit entitlements and are generally only offered on an indemnity basis (¶4-320).

CLAIMS PROCESS ¶7-960 Lodging an insurance claim Clients who wish to make a claim against an insurance policy will need to complete the claims form provided by the life insurance provider. This form should be completed fully and all evidence and documents requested should be provided. This may help to avoid delays in the claims process. The claim needs to be lodged by the policy owner but if the life insured was the policy owner and that person has deceased, it will be the legal personal representative (ie the executor or administrator of the estate). If the policy owner is still alive but not capable of lodging the claim (due to illness or injury) it may be lodged by the enduring power of attorney or other authorised person. The claim should be lodged as soon as possible. Apart from getting access to claim proceeds quickly the policy will usually specify that the claim must be lodged within a certain period of time to be valid. This requirement applies because the sooner the claim is lodged the easier it is for the life company to obtain the evidence needed to assess the claim. Delays in lodging may indicate the potential for a fraudulent claim or make it more difficult to assess. If the claims officer determines that there was an unnecessary delay in lodging the claim and this hinders

the ability to obtain all necessary evidence the claim can be reduced.

¶7-965 Verifying an insurance claim If a client suffers the insured event they need to lodge the claim form with the life insurance provider’s claims department. The claims department will check: • that the policy is valid and still in force (including payment of all premiums) and that the event occurred during the currency of the policy. • verification of the claimant and their entitlement to make a claim — ie the policy owner or authorised representative. • that the event being claimed meets the insurance definition in the policy document and is not an excluded event under the policy or for that person in the policy schedule. For example, most policies include exclusions for suicide within the first 13 months, war-related injuries and pre-existing conditions that were not disclosed in the application process. • details of any treating medical practitioner who may need to be consulted in relation to the diagnosis to process the claim. Medical reports are likely to be needed from the relevant practitioners. The claimant may need to sign to give permission for these to be obtained as part of the claims process. In the medical practitioner’s report, the claims officer will be looking for verification that the diagnosis meets the policy definitions and the prognosis. They will also be looking for any indication that it was a pre-existing condition that was disclosed in the application.

¶7-970 Investigation and surveillance The claims process often requires more than one medical report. It may require a report from the usual general practitioner as well as treating specialists. If there appears to be contradictions within these reports, or the wording indicates some suspicious that the claim is not genuine, the claims officer may decide that surveillance and further investigation is required. This surveillance may include obtaining further medical assessments from a doctor who specialises in insurance claims or physical surveillance to track the activities of the claimant. The claims officer could also elect to obtain a report from Medicare. This will show a history of medical appointments and treatments which were claimed through the Medicare system. This can help to indicate whether a condition was non-disclosed or if full information has not been provided to the life insurance company either at the time of application or claim. If the claimant does not appear to have a regular doctor or has advised that they have not been to a doctor for many years this may trigger a decision to obtain a Medicare report to validate the medical history.

¶7-975 Insurance policy waiting periods Income protection policies generally have a waiting period (¶7-340). The length of this period may depend on the policy and can be selected by the policy owner at the time of application. The waiting period will be specified in the policy schedule. Most policies will commence the waiting period from the time the person first visits a medical practitioner after they have ceased working, not the date of the event. This is because it is easier to verify the date of a medical appointment than the date of the accident or illness commencing. Example Alice had an injury in a sporting event on the weekend. She injured her back and had swelling and pain. However, she continued to

go to work for the following three days. The back problem continued and later in the week she visited her doctor. The problem was identified as a serious injury requiring several months off work. Alice’s income protection policy has a 30-day waiting period. The claim is approved and payments will commence 30 days after the initial doctor’s appointment.

For this reason, it is important that clients visit a doctor as soon as possible if they think the event may lead to an insurance claim so that commencement of the waiting period can be clearly established. Wording in the policy document should also be reviewed.

¶7-978 Comparing claims performance Life insurance policy holders are now able to review and compare the claims and dispute handling performance of different life insurance providers. The Australian Securities and Investments Commission’s (ASIC) MoneySmart website (www.moneysmart.gov.au) now includes a claims comparison tool. This compares data for death, TPD, trauma, income protection, consumer credit insurance, funeral insurance and accidental death and injury insurance. The data reported includes details on: • claims acceptance rates from total claims processed • average time to decide whether to accept a claim or not • the number of claims related disputes • the percentage of policies cancelled by the insurer or the policy holder.

LIFE INSURANCE COMPLAINTS PROCESS ¶7-980 Raising a life insurance complaint If a dispute arises, the steps for a resolution are as follows: 1. Check the policy document — check to see if the client has been treated unfairly and has grounds to raise a complaint or whether the life insurance company is acting within the policy terms and conditions. 2. Raise the issue with the life insurer — to determine if the issue can be satisfactorily resolved. 3. Follow the internal complaints process — the PDS or policy document should provide details for how to lodge a complaint with the life insurance company. This complaint will generally need to be made in writing. Also take note on how long the provider has to respond to the complaint. 4. If not resolved, escalate the complaint to the Australian Financial Complaints Authority (AFCA), the various contact methods can be found online at www.afca.org.au. (¶8-615).

¶7-985 Complaints for insurance inside superannuation If the life insurance policy is held inside superannuation, complaints which relate to decisions made by the superannuation fund trustee can be referred to the Australian Financial Complaints Authority (AFCA) which replaced the Superannuation Complaints Tribunal on 1 November 2018. There is no charge for the member (or beneficiaries) to lodge a complaint. The process to have it resolved may be lengthy and this may tie up access to the money for one to two years. Information on AFCA is available at www.afca.org.au (¶8-615).

The most common complaints relate to decisions on whom to pay death benefits to and whether a person has met the permanent incapacity condition of release.

Tip Holding insurance inside superannuation may provide benefits to the client. But if a dispute occurs when the benefits are being withdrawn from superannuation this may cause significant delays in accessing the money and at a time when the need for the money is critical. When providing advice to clients on insurance inside superannuation it is important for advisers to also consider advice on binding death benefit nominations (¶19-365) and other estate planning implications to minimise the potential for disputes and lengthy delays.

LIFE INSURANCE FRAMEWORK AND REMUNERATION REFORMS ¶7-990 Life insurance framework The reform of the life insurance industry has been in progress since 2014, resulting from the following reports: • ASIC Report 413: Review of Retail Life Insurance Advice • Financial System Inquiry (Chaired by David Murray) • Trowbridge Report — the Review of Retail Life Insurance Advice • Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (¶7-999). Concerns were raised from these reports in relation to upfront commissions and policy churn. The Financial System Inquiry recommended the abolition of upfront commissions and a move to level commissions. The Trowbridge Report recommended a reduction in upfront commissions. The government announced a Life Insurance Framework (LIF) which was finalised in November 2015 following industry consultation as a way forward to reform the life insurance industry. The LIF created a plan for remuneration practices, transitional arrangements, codes of conduct, financial adviser monitoring as well as enforcement. It led to the passing of legislation which came into effect from 1 January 2018 (¶7-995). Other requirements which stemmed from the LIF include: • compulsory educational requirements for financial advisers (both new and existing) • supervisory requirements for new financial advisers • a code of ethics for the life insurance industry • an exam that will be benchmarked across the financial adviser industry, and • ongoing training requirements. Trowbridge Report and outcomes The FSC and the Association of Financial Advisers (AFA) set up a Life Insurance and Advice working group chaired by John Trowbridge. The role of this group was to review the incentives identified in a damning report issued by ASIC in October 2014 called the Review of Retail Life Insurance Advice and to

make recommendations on how the insurance advice industry could respond to ensure that Australians are adequately insured and receive quality financial advice. The Trowbridge Report was released in March 2015 with 11 recommendations, including: • reductions in upfront commissions • broadening of approved product lists • introduction of a life insurance code of practice. The FPA, AFA and FSC jointly developed a package of proposals in response to Trowbridge which was put forward to government. Life Insurance Industry Report In September 2016, the Senate referred an inquiry into the life insurance industry to the Joint Parliamentary Committee on Corporations and Financial Services. The terms of reference included: • the need for further reform and oversight • assessment of benefits and risks to consumers of the direct, group and retail-advised insurance elements • the sales practices of life insurers and brokers • the effectiveness of internal dispute resolution, and • the roles of the regulators — ASIC and APRA. The report was released on 27 March 2018 and included recommendations on the following: • Audits — ASIC to conduct random audits on 20% of life insurance advisers over three years. • Remuneration — ASIC and APRA to examine all payments, benefits and fees across life insurance industry as the view is that the ban on conflicting remuneration has not been effective and is still showing signs of misconduct and poor practice. • Stronger regulatory oversight and extension of banking executive accountability regime to the sector. • Codes of practice — combine the two life insurance industry codes of practice into a single code which is enforceable by ASIC under a co-regulatory approach. Develop a mandatory and enforceable Code of Practice for mental health life insurance claims. • Approved product lists — the lists should be expanded to include a better balance of affiliated and non-affiliated products with clients given comparisons with non-affiliated products, in addition ASIC and the Australian Competition and Consumer Commission (ACCC) to investigate whether the past use of APLs has breached anti-competitive laws due to the lack of transparency and conflicts of interest. • Claims — the industry should use clear and simple language to explain definitions and standardise definitions across all types of policies. The definitions should be regularly updated to align with current medical knowledge and research. It was also recommended that the claims process come under ASIC regulatory capacity. • Medical examinations — set industry standards for claim timeframes and limits on the number of medical examinations. • Superannuation funds — an immediate review of all trustees to determine compliance with SIS provisions and to ensure only appropriate insurance policies are being purchased.

¶7-995 Life insurance commissions and conflicted remuneration The Corporations Amendment (Life Insurance Remuneration Arrangements) Act 2016 (the Act) and the Corporations Amendment (Life Insurance Remuneration Arrangements) Regulations 2017 came into effect on 1 January 2018 to remove the previous exemption from the Corporations Act ban on conflicted remuneration that applied to life insurance products. This legislation arose from the Life Insurance Framework (¶7-990) to: • address issues around the quality of advice that were identified in ASIC’s Report 413 on the Review of Retail Life Insurance Advice in 2014 • minimise the required government intervention using recommendations from the Financial System Inquiry and Trowbridge Report • allow consumers to access non-conflicted and appropriate advice on life insurance • place consumer interests first and avoid churning for adviser remuneration purposes by capturing life insurance products under the ban on conflicted remuneration. From 1 January 2018, conflicted remuneration provisions of the Corporations Act apply to life insurance unless a specific exemption applies. These exemptions are outlined in ASIC’s Corporations (Life Insurance Commissions) Instrument 2017/510. In addition, the Regulations extend the conflicted remuneration provisions to dealing and information services as well as general and personal advice on life insurance. Grandfathering provisions apply to insurance products in place before 1 January 2018 but are to be phased out by 1 January 2021. Remuneration changes The new rules provide a transition from high upfront commissions to either a hybrid commission, level commission or a fee for service advice model. The rules also apply under the Regulations to sales where no advice is given. Exemptions from the ban on conflicted remuneration (ie commissions) apply to arrangements approved by ASIC which provide clawbacks if the policy is cancelled or the premium cost is reduced within the first two years. These exemptions are outlined in ASIC’s Corporations (Life Insurance Commissions) Instrument 2017/510. This means that monetary benefits relating to the arrangements that meet the terms in the Instrument are not conflicted remuneration. The exemptions do not apply to group life risk policies (inside or outside superannuation) or individual life insurance policies in default superannuation funds. The exemption means that commissions can still be paid on life insurance products that meet the following rules from 1 January 2018: • upfront commissions were capped at 80% of the policy cost, but then further reduced to 70% from 1 January 2019 and 60% from 1 January 2020 (plus GST) • trailing commissions in subsequent years are capped at 20% (plus GST), and • a two-year clawback provision applies. Under the clawback provisions 100% of upfront commissions must be repaid if the policy lapses or is cancelled or the policy cost is reduced in the first year. A 60% clawback applies if this occurs in the second year. The clawback is not applicable if cancellation is due to circumstances such as death, selfharm or payment of a claim or the premium reductions are due to genuine circumstances such as a shift to non-smoking status. When a clawback applies it is to be calculated against the total policy cost (or reduction in total policy cost). If the client takes action to increase the policy cost, the same commission cap levels apply to the policy

cost increase. If the commission is paid in instalments it is taken to be commission for the year in which the increase incurred. If the commission includes GST this amount is in addition to the capped amount. ASIC Regulatory Guide 246 ASIC has updated Regulatory Guide 246 Conflicted and Other banned Remuneration (RG 246) to include guidance on the life insurance remuneration reforms and working examples. ASIC will continue to monitor the industry’s implementation of the reforms.

¶7-997 ASIC sample life insurance SOA ASIC has released a new example Statement of Advice (SOA) for life insurance. This is included in the Regulatory Guide 90 Example Statement of Advice: Scaled advice for a new client (RG 90). The example SOA is based on a hypothetical limited advice scenario. This may help financial advisers to understand how to produce a clear and concise advice document for advice on life insurance and aim to improve consumer understanding.

¶7-998 Life insurance codes of practice The Life Insurance Code of Practice The Life Insurance Code of Practice (the Code) developed by the FSC is binding on all life insurance members from 1 July 2017. However, it is not enforceable by ASIC. It aims to provide clients with a set of standards by which to judge their insurer as well as improve standards of service and practice within the life insurance industry. The Code covers many aspects of a customer’s relationship with their life insurer, from buying insurance to making a claim, to customers requiring additional support and standards for third parties dealing with underwriting or claims. This Code does not apply to life insurance products issued by superannuation fund trustees, as these policies are covered under the code developed by the Insurance in Superannuation Working Group (ISWG). Nor does it include general insurance or health insurance policies. In November 2018, the FSC announced changes to radically overhaul the Code and intended these changes to be enforceable from 1 July 2019. However, stakeholder review led to a deferral due to feedback on the need for further consultation, a rewrite in simpler English and approval from ASIC. While most of the changes have been deferred, the FSC has announced that the moratorium on life insurance genetic testing results will become a binding standard from 1 July 2019 (¶7-410). This change will allow all Australians to apply for life cover up to $500,000 without having to disclose an adverse genetic testing results. Insurance in Superannuation Voluntary Code of Practice The ISWG was formed in November 2016. The result was the development of the Insurance in Superannuation Voluntary Code of Practice, which is co-owned by the Australian Institute of Superannuation Trustees (AIST), the Association of Superannuation Funds of Australia (ASFA) and the FSC. This voluntary Code aims to set standards for improving superannuation member value and protections. The overall objective is to build confidence through consistency across the industry. The Code came into effect from 1 July 2018 with a three-year transition period. It was updated in March 2020 in line with changes to introduce opt-in of insurance for low-balance and inactive accounts. Some of the key policies included are: • ensuring insurance design and offer is affordable and appropriate for members — the insurance policy of the superannuation fund will be published on its website, including details on how the default insurance has been designed. Premiums for automatic insurance members aim to be no more than 1% of the estimated salary level for the membership in general

• giving greater consideration to the design and pricing of insurance for younger members • publishing a Key Facts Sheet for automatic insurance covers • members will be able to cancel insurance at any time. If contributions have not been received for at least six months, the fund will write to the member to highlight the impact of insurance premiums on superannuation balances • giving clearer explanation of insurance policy and claim definitions • making procedures and standards around claims handling and complaints as straight forward as possible.

¶7-999 Recommendations from the Royal Commission The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry is likely to have an impact on all areas of financial services and advice, including life insurance. One of the proposals in the final report recommended the abolition of grandfathered commissions on all financial products and commissions relating to life insurance be reduced and eventually eliminated (refer to ¶7-995 for details on commissions). Other key recommendations in the final report that may impact insurance include the following: Recommendation 4.1 — No hawking of insurance The recommendation was to prohibit the unsolicited spruiking and selling of insurance products, which affects the activities of insurance providers rather than financial advisers. Recommendation 4.5 — Duty to take reasonable care not to make a misrepresentation to an insurer Currently, the consumer has a duty of disclosure to the insurance provider, and it was recommended to replace this with a duty to take reasonable care not to make a misrepresentation to the insurer. This would place the responsibility back onto the insurer to ask for all the information that might be important to assess their risk level and acceptance of that risk. Recommendation 4.6 — Avoidance of life insurance contracts The aim of this recommendation was to ensure that in a case of non-disclosure or misrepresentation, an insurer can avoid the life insurance contract only if it can be shown that they would not have accepted the policy on any terms. Recommendation 4.8 — Removal of claims handling exemption Consumer protection was recommended to be strengthened by including claims handling under the definition of a financial service in the Corporations Act. Recommendations 4.9 and 4.10 — Enforceable code provisions and extension of sanction powers It is recommended that the FSC, the Insurance Council of Australia and ASIC take steps by 30 June 2021 to set as enforceable code provisions the sections of the following codes that deal with the terms of the contracts between the insurer and the policy holder: • The Life Insurance Code of Practice • The Insurance in Superannuation Voluntary Code, and • The General Insurance Code of Practice. Powers should be given to the Life Code Compliance Committee or the Code Governance Committee to impose sanctions if an insurer breaches the applicable Code. Recommendation 4.13 — Universal terms review

It was recommended that Treasury consult with the industry to determine the feasibility of legislating universal key definitions, terms and exclusions for default MySuper group life policies. At the time of writing, legislation had not yet been introduced to give effect to any of these recommendations. Changes are likely to be deferred until the completion of an ASIC review of the Life Insurance Framework in 2021.

COMPLIANCE AND BEST PRACTICE FOR FINANCIAL ADVISERS The big picture

¶8-000

The framework of compliance What is compliance for financial advisers?

¶8-010

The legislative framework for the financial system

¶8-020

Best practice Overview of financial adviser best practice

¶8-100

Key elements of best practice

¶8-110

Duty to act in client’s best interest

¶8-120

Duty to give appropriate advice

¶8-125

The pre-FASEA, pre-FOFA duty to give quality advice

¶8-130

Duty to act efficiently, honestly and fairly

¶8-140

Duty to disclose conflicts of interest

¶8-150

Disclosure of adviser remuneration

¶8-155

Duty to ensure proper competencies, experience and training ¶8-170 Duty to provide adequate supervision

¶8-180

Duty to adhere to professional codes and standards

¶8-190

Regulation of financial services What is a financial product?

¶8-220

When is a financial service provided?

¶8-230

Retail or wholesale client?

¶8-240

Uniform licensing regime

¶8-250

Training of financial product advisers

¶8-260

The introduction of FASEA, the exam and the Code of Ethics

¶8-265

Restrictions on use of terminology

¶8-270

General obligations of licensees

¶8-280

Disclosure obligations when providing financial services

¶8-290

The Financial Services Guide (FSG)

¶8-300

Statement of Advice

¶8-310

Record of Advice

¶8-315

Product Disclosure Statement (PDS)

¶8-320

Tax-related advice

¶8-350

Anti-money laundering and counter-terrorism financing

Anti-money laundering and financing of terrorism

¶8-370

Consumer protection Overview of consumer protection

¶8-400

Misleading and deceptive conduct

¶8-405

Fair trading and the Australian Consumer Law

¶8-410

Restrictive trade practices

¶8-415

Consumer protection under the Corporations Act 2001

¶8-420

Other consumer protection laws

¶8-425

Privacy compliance Australian Privacy Principles — the APPs

¶8-510

Adviser’s role in privacy compliance

¶8-520

Complaints handling The modern complaints handling system for financial advisers ¶8-600 How the adviser should act following a complaint

¶8-610

External dispute resolution

¶8-615

¶8-000 Compliance and best practice

The big picture This chapter deals with the compliance issues that face financial advisers. Advisers are under immense pressure to comply, particularly since the introduction of the Financial Services Reform Act 2001 (FSRA) and the Corporations Amendment (Future of Financial Advice) Act 2012 (FOFA), and the Corporations Amendment (Further Future of Financial Advice Measures) Act 2012 .................................... ¶8-010 Financial Planners and Advisers Code of Ethics 2019 In February 2019, the Financial Adviser Standards and Ethics Authority (FASEA) introduced the most significant reforms to financial advice since FOFA with the release of the Financial Planners and Advisers Code of Ethics (better known as the FASEA Code). In addition to the statutory and regulatory requirements that financial advisers and licensees are subject to, the Code has introduced a broad set of ethical obligations distilled into five overarching values and 12 ethical standards. .................................... ¶8-020 Future of Financial Advice The Future of Financial Advice (FOFA) reforms were the most significant changes to the way advice is provided to retail clients since the introduction of the Financial Services Reform Act (FSRA) in 2001. They changed the landscape of the provision advice and how financial products are recommended to clients .................................... ¶8-020 Best practice principles To ensure an adviser acts ethically and in their client’s best interests at all times, it is necessary to adopt “best practice” principles. Generally, this means performing fiduciary and compliance duties and adopting certain business practices such as the “know-your-client, know-your-product” and “best interest duty” rules .................................... ¶8-100 Fiduciary best interest duty at general law

Acting in the client’s best interest has always been a requirement under general law when acting as a fiduciary. The FOFA reforms have introduced a statutory best interest duty along with civil penalties for non-compliance .................................... ¶8-120 Providing appropriate advice FSRA introduced the concepts of the suitability rule and informed consent to providing advice. However, FOFA took this to the next level by prescribing rules for providing appropriate advice and providing a safe harbour for complying with the best interest duty when providing financial product advice .................................... ¶8-130 Advisers need to: • consider the client and their literacy and numeracy skills and their investment experience. Where industry jargon is used, advisers should ensure the terms are explained and understood • consider the purpose of the advice and ensure it is prepared with sufficient information to enable the client to make an informed decision • identify and clarify the client’s objectives, financial situation and needs • identify the subject matter and then scope it in terms specific to the client: – what has the client requested the adviser to do? – what are the client’s goals and objectives (use the client’s words and not template wording) – is the advice request triggered by an event, eg divorce, redundancy. • set out the scope of the advice. Note that it can be limited by either party subject to some conditions, that is, scaled advice • ensure the adviser has sufficient knowledge about the relevant strategies and specific products to provide the advice • provide specific and detailed recommendations and ensure the important aspects of the advice are set out and the adviser has adequately explained the reasons underlying the recommendations • explain how the client will be better off if they follow the advice and how it is in their best interest to follow the advice • explain the risks associated with the advice in language the client can understand. Prohibition on conflicted remuneration FOFA prohibited certain conflicted remuneration that provided a reasonable expectation to influence the advice to be given and thus enabled advisers to act in their self-interest to the disadvantage of clients. In response to recommendations from the Final Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, legislation was enacted to end grandfathering of pre-FOFA commissions from 1 January 2021 .................................... ¶8-155 Raising professional standards for advisers New education and training requirements became effective from 1 January 2019. Existing advisers will have until 1 January 2022 to pass an exam and until 1 January 2026 to reach degree equivalent status. A code of ethics requirements came into force from 1 July 2019 .................................... ¶8260 Financial services regulation All advisers who provide financial services in relation to financial products must comply with Ch 7 of the Corporations Act. The disclosure requirements are rigid when advisers are providing personal

advice to retail clients .................................... ¶8-220–¶8-350 Consumer protection Fair trading laws prohibit advisers giving the wrong impression, treating clients unfairly and providing false statements. Guidelines on how to avoid these prohibitions are provided .................................... ¶8-400 A restrictive practice is one that interferes with, or tries to reduce, the extent of competition in the market. Guidelines are also provided for advisers to avoid these practices .................................... ¶8410 Privacy compliance These rules control the way a business handles an individual’s private details. It is now mandatory for a wide range of organisations to notify the Australian Information Commissioner and affected individuals when an eligible data breach occurs .................................... ¶8-510 Complaints handling and dispute resolution Practical assistance is provided for advisers about how they should handle a complaint using the modern complaints handling system. A new dispute resolution body — Australian Financial Complaints Authority (AFCA) — replaced the FOS, CIO and SCT on 1 July 2018. ASIC released a consultation paper on lifting standards and transparency of complaints handling with comments closed from 9 August 2019. .................................... ¶8-610

THE FRAMEWORK OF COMPLIANCE ¶8-010 What is compliance for financial advisers? Compliance is a set of legislated obligations, regulatory requirements and business policies and behaviours that companies and Financial Service Licence holders (known as AFSLs) must meet. Financial advisers in Australia face a heavily regulated industry. The main areas of legislation affecting licensees and advisers are the Corporations Act 2001 (particularly Ch 7), the Corporations Amendment (Future of Financial Advice) Act 2012 (FOFA), the Financial Services Reform Act 2001 (FSRA), the Tax Agent Services Act 2009 (TASA) and the Trade Practices Act 1974 (TPA). Other legislation include the Australian Securities and Investments Commission Act 2001 (ASIC Act), Privacy Act 1988, Spam Act 2003, Anti-Money Laundering and Counter-Terrorism Financing Act 2006, the Corporations Amendment (Future of Financial Advice) Act 2011, the Corporations Amendment (Further Future of Financial Advice Measures) Act 2012 and regulations under each of these Acts as well as ASIC Regulatory Guides (previously known as Policy Statements). There are a number of statutory and government bodies that have specific relevance in how financial advisers and licensees are regulated including the Australian Securities and Investments Commissions (ASIC), the Australian Prudential Regulatory Authority (APRA), the Tax Practitioners Board (TPB), the Australian Transaction Reports and Analysis Centre (AUSTRAC), the Australian Taxation Office (ATO), the Office of the Australian Information Commissioner (AOIC) and the Australian Financial Complaints Authority (AFCA). ASIC has produced a plethora of reports, regulatory guides (formerly known as policy statements), information sheets, consultation papers, legislative instruments and class orders to provide guidance to financial advisers and licensees on interpretation and implementation of the law. Much of the legislation and regulation financial advisers and licensees operate under was put under the spotlight during the recent Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (known as the Hayne Royal Commission after the Commissioner, former High Court Justice the Hon Kenneth Hayne AC QC). Compliance functions in a number of ways such as:

• a check and balance for the financial services industry and the licensee. Compliance with financial services laws is intended to protect clients from poor practice and ensure all financial service companies maintain specific corporate behaviour • meeting applicable compliance obligations requires a licensee to act efficiently, honestly and fairly with clients. Financial Services Reform Act The FSRA was introduced to develop a consistent and effective regulatory environment, bringing together: • Ch 7 and 8 of the Corporations Act • the Insurance (Agents and Brokers) Act 1984 • aspects of the Superannuation Industry (Supervision) Act 1993 (SISA) • the Retirement Savings Account Act 1997 • the Insurance Act 1973 • the Australian Securities and Investments Commission Act 2001 (ASIC Act) • the Reserve Bank Act 1959, and • aspects of the Banking (Foreign Exchange) Regulations. The primary effect of the FSRA was to amend the Corporations Act to provide a single regulator for advice which now covers the insurance, investment and retirement advice industry. It also sets out licensing requirements for companies and individuals providing financial product advice. The cornerstone to any financial advice must be a firm commitment to good ethics and putting the interests of the client first. However, prior to the introduction of the FSRA, financial advice was very much a sales industry where advisers earned commissions from selling financial products such as superannuation, life insurance, managed investments and retirement income products. An adviser’s analysis of the suitability of a financial product was arguably based more on what the client could afford rather than what client actually needed. High upfront commissions encourage “churning” whereby advisers could switch their clients to a new product on a regular basis, even when the client’s current product was performing well. The FSRA introduced the now repealed s 945A of the Corporations Act which required the adviser to first determine the relevant personal circumstances of the client, to make reasonable inquiries in relation to their personal circumstances, and having given consideration to, and conducted an investigation of, the subject matter of the advice, determined on the basis of their consideration and investigation, that the advice is appropriate to the client. The need to determine a “reasonable basis” for any recommendations was really the first step to putting the client’s interests above those of the adviser. The FSRA also introduced the “Statement of Advice” or “SoA”. Prior to this, advice and product recommendations had generally been delivered via a short-form Customer Advice Record (CAR), especially for life insurance, which was usually no more than two pages and showed the company, the amount of cover and the premium to be paid. Many investment and superannuation advisers produced longer “financial plans” which were really not too dissimilar to an SoA, detailing the clients’ personal information and their goals, the product recommendation, potentially some modelling to support the recommendations, some level of disclosure of fees and charges and disclaimers and other general information. The FSRA not only legislated obligations on giving an SoA, but also what it needed to include, when it had to be given and introduced rules that required the adviser and licensee to adequately disclose the

benefits lost when recommending replacing one financial product with another. The replacement product requirements are still a key feature of compliant advice today. Corporations Amendment (Future of Financial Advice) Act The FOFA reforms introduced the most significant changes to financial advice since the FSRA. Following many investigations and inquiries that showed the FSRA was not working as adequately as it should be, the then Labor government introduced the FOFA legislation in July 2012, introducing greater consumer protections and with the intent to rebuild trust and confidence in the financial services sector. The three main objectives of FOFA were to introduce a best interest duty (which enshrined in legislation a fiduciary obligation to put the needs of the client first), to ban conflicted remuneration by removing commissions and volume-based payments which could influence an adviser in recommending a financial product and to introduce client engagement and ongoing fee disclosure requirements. These reforms required clients to “opt-in” to ongoing fee arrangements (OFAs) with their advisers so they knew what they were paying for but also to be provided an annual Fee Disclosure Statement (FDS) so they know what services they actually received. 1. Best Interest Duty A legislated best interest duty requires that financial advisers must act in the best interests of their clients, subject to a “reasonable steps” qualification, and place the best interests of their clients ahead of their own when providing personal advice to retail clients. The legislated safe harbour provisions in s 961B(2) of the Corporations Act allow advice providers to rely on a series of requirements to show they have met the best interests duty. This is intended to be the minimum standard of compliance with the best interests duty. It should be noted that the statutory best interest duty does not replace the fiduciary duties under common law. 2. Ban of Conflicted Remuneration A prospective ban on conflicted remuneration structures including commissions and volume-based payments, in relation to the distribution of, and advice about, a range of retail investment and superannuation products. This ban does not apply to some products and advice services, such as: • general insurance where the benefit only relates to a general insurance product • basic banking products where advice is only given on a basic banking product • financial product advice given to wholesale clients, and • advice where the client pays the benefit to the provider (eg fee for service arrangements). Note that grandfathering arrangements, whereby licensees could continue to receive commissions from investment and superannuation products post-FOFA, are legislated to cease from 31 December 2020. 3. Ongoing Client Engagement and Fee Disclosure An opt-in obligation requires advice providers to renew their clients’ agreement to ongoing fees every two years. From 1 July 2015, an exemption under s 962CA of the Corporations Act applied to advisers who are members of a professional association that has an ASIC-approved code of conduct which makes the need for the opt-in provisions unnecessary. This provision was never really adopted in practice by the industry and with the recommendations stemming from the Royal Commission, opt-in is set to be on an annual basis from 1 January 2021. An annual FDS applies to existing and new retail clients. The retrospective disclosure applies to fees and services provided (and not to trail commissions included in forming part of the products Managed Expense Ratio (MER)). Future costs and services are not required to be included. Flexibility exists to allow an FDS to be provided in a way that suits a particular adviser’s business, for example, reporting on the same day each year for all clients rather than on the anniversary of when they became clients. Who is an adviser? This chapter deals with the compliance issues that face advisers. “Adviser”, in this chapter, refers to the individual adviser who gives financial product advice on investment, insurance and other financial

products such as superannuation. When “licensee” is referred to, it is referring to the holder of an AFSL. The chapter will also be of value for those licensees who actively give advice, but generally, it does not address their wider responsibilities as licensees. A culture of compliance Having a culture of compliance is crucial. It is an integral part of good ethics and risk management. A culture of compliance occurs in an organisation where advisers comply with their fiduciary duties automatically. However, this can take some time to achieve so continuous reinforcement is necessary as well as the culture of adopting best practice principles (¶8-100–¶8-190). The best way to embed compliance into best practice is to determine a vision for the customer service that advisers want to provide. The adviser needs to consider what compliance procedures they have in place now, and how they can better fit them into the advice process so that it appears seamless to the customer while adding value to the experience. This becomes even more important with the opt-in and best interests duty obligations and safe-harbour provisions introduced under FOFA. By constantly developing and improving mandatory procedures to meet best practice, advisers will minimise any future modifications required as the legislation moves further into areas currently considered best practice.

Note Compliance: – is part of any commitment to ethics and corporate governance and risk management – should be an integral part of the business’s ongoing operation and not merely a “look back” annually – is a practical management system that enables advisers to get on with their business by ensuring rules and regulations are not breached – involves effective management of operations with the intention of “getting it right” first time – enables licensees to actively monitor, on an ongoing basis, advice provided by their advisers.

Advisers’ need for a compliance system Licensees must have an effective compliance system in place. This system should be documented and reviewed regularly. It is good practice to have an external review of the compliance system on a regular basis. The timing will depend on the size and complexity of a licensee’s business and should be undertaken when there has been a change in business operations. Advisers also need their own compliance mechanisms to ensure they are not exposed. Advisers are potentially subject to a considerable number of offences, which can result in high penalties and the loss of their authorities. Licensees will need to require advisers to comply with strict procedures in order to protect themselves. With compulsory professional indemnity (PI) insurance in place (¶8-420), licensees and advisers without effective compliance systems will find it difficult, if not impossible, to obtain PI insurance.

Tip The best defence against breaches is a suitable compliance system.

Advisers’ role in the compliance system The law is primarily embedded in financial planning by virtue of the licence conditions under the Corporations Act. It comes down to one simple aim — no licence, no practice. The common approach for a licensee to address its licence conditions is via a documented compliance regime. An effective compliance regime will address all legal, policy and ASIC requirements, as well as incorporate standards to provide both a procedural and behavioural basis on which a financial service is provided. It will also provide the basis for a defence on FOFA safe harbour grounds. Advisers need to: • understand and adhere to the compliance system in place • ensure they are only giving advice to the extent of their authority issued by their licensee • meet all disclosure obligations — both written and oral • avoid looking for loopholes and shortcuts — the policies are in place for a reason • report any breaches or concerns immediately to their licensee • resolve complaints as quickly as possible if they receive one by working with the customer to resolve it • always look for greater ways to improve customer service, but check with their compliance officer and licensee before implementation • use the standard documents and software issued by the licensee • work with the person who undertakes the adviser monitoring process to provide as much information to assist in determining their level of compliance • treat monitoring as an opportunity to learn more about their obligations and how best not to contravene them • respond promptly to any reports issued from compliance monitoring • become active in promoting compliance best practice within their business.

Tip In considering whether an adviser has adequately complied with the safe harbour provisions, the adviser should ask themselves “If I had to defend these recommendations in a witness box, could I?”

A compliance review How does an adviser know whether their compliance procedures are working? The simple answer is through a review of the compliance process through active monitoring and reviewing client complaints to determine any systemic issues. How does an adviser know whether their compliance allows the licensee to determine whether its representatives are complying with the legislation (including licence conditions)? The Corporations Act requires that a licensee monitors and supervises the activities of representatives to ensure they are complying with the financial services laws. Regulatory Guide (RG) 104.73 states that ASIC does not anticipate that the monitoring and supervising will involve the licensee scrutinising every activity of all its representatives. However, it will only consider the monitoring and supervision structure to be adequate if it: • allows the licensee to determine whether its representatives are complying with the legislation

(including licence conditions) • establishes a robust mechanism for remedying any breaches. As with all compliance obligations set out in RG 104 and RG 105, any monitoring and supervision process must document a series of measures, processes and procedures that will be undertaken. ASIC has stepped up its surveillance of licensees and in particular is closely scrutinising licensees’ obligations to demonstrate the existence of adequate monitoring and supervision regarding the: • monitoring and supervision of authorised representatives activities to ensure compliance with the law, and • training processes and education of authorised representatives to ensure sufficient training is provided.

Tip An external compliance review is recommended on a regular basis.

When to carry out compliance reviews of advice provided The nature and frequency of compliance reviews is dependent on the size of the financial planning practice. As a general rule of thumb, new representatives should be closely monitored and supervised for a period of at least three months (or a set number of SoAs), with their SoAs being pre-vetted prior to being provided to the client. Post-vetting of advice should occur once the initial pre-vetting stage is completed. Post-vetting can be a combination of scheduled reviews, random assessments and should include an annual full vet as part of the compliance audit. Annual post-vetting should include file reviews, interview with the adviser and examination of premises. Any remedial action should be documented and carefully followed up by appropriate management. In addition, monitoring procedures should be in place to deal with matters that require immediate action, due to either a licence breach or potential risk to client funds. A good guide is to also regularly monitor complaints and determine whether there is any trend or particular representative “popping up”. Funding and resources Adequate funding must be budgeted for and immediate action monitored, with adequate resources dedicated to the task. The compliance review process should be undertaken by qualified staff either internally or outsourced.

Note It is important to note, however, that if the compliance function is outsourced, the licensee remains liable for the monitoring activities in the context of the service it provides to a client.

Compliance breaches One of the key AFSL obligations is to have compliance systems that are designed to provide reasonable assurances that breaches will be identified and reported.

All breaches must be self-reported (ie logged internally), and significant breaches must be reported to ASIC within the prescribed time periods. ASIC will not react kindly if the licensee’s compliance review shows a number of compliance breaches on which the licensee or adviser fails to act. A compliance review program must include an effective disciplinary and breach management procedure. It is therefore important that all staff (not just the licensee or advisers) are: • able to identify potential breaches, and • familiar with breach reporting policies and procedures. What is a breach? A breach, simply put, is any failure to comply with any of licensees’ regulatory obligations. In addition, a situation where a licensee is likely to fail to comply with its regulatory obligations in the future could also be a breach. ASIC has provided guidance on breach reporting or licensees, particularly in Regulatory Guide RG 78. ASIC has indicated that many breach notifications do not contain all the information it needs to assess the breach or to understand how the licensee proposes to deal with the breach and its consequences. To help licensees, ASIC has developed a template form for lodging written breach reports. A copy of the form (FS80) is available on ASIC’s website at www.asic.gov.au/forms. The form is provided for assistance only and the use of it is not compulsory. Reviewing the compliance program Finally, the compliance program itself should be regularly reviewed. Given the ongoing regulatory changes and operational risks, it is prudent to schedule a review of the compliance program annually, with a full external audit at least once every three years. The compliance audit should assess whether the procedures continue to address the legislative and licence requirements, as well as the operational risks of the business. ASIC has issued Regulatory Guides (RGs) RG 104 and RG 105 to assist licensees. These are outlined below. Note that these RGs replaced RG 164. RG 104 RG 104 looks at the general aspects of compliance. It stresses the following: • documenting a licensee’s compliance measures which helps the licensee analyse whether it is in compliance with general obligations • implementing, monitoring and reporting on the measures is also vital, as all levels of the entity should be current with compliance details, and • all relevant compliance breaches must be recorded as well as demonstrated to ASIC that they are handled correctly. RG 104 sets out issues that ASIC believes should be considered in relation to monitoring, supervision and training. In assessing a representative’s compliance, the following issues are listed: • What monitoring and supervision measures, processes and procedures have the licensee adopted to determine whether representatives are complying with the financial services laws? • Does the monitoring and supervision procedure address higher risk activities of the representatives? • How does the licensee ensure that it is not receiving inaccurate information? • Who carries out these measures, processes and procedures, and how often? • How are breaches rated?

RG 105 RG 105 sets out issues relating to organisational competence, where an entity is an AFSL holder. They must maintain the competence to provide the financial services covered by the licence — s 912A(1)(e) of the Corporations Act. It must: • provide financial services only covered by the AFSL • keep records and review organisational competence • nominate Responsible Managers (RM) who: – are directly responsible for significant day-to-day decisions about the ongoing provision of the entities’ financial services – together, have appropriate knowledge and skills for all the entities’ financial services and products – individually, meet one of the five options for demonstrating appropriate knowledge and skills, in order to ensure that the licensee has measures in place to ensure the licensee maintains organisational competence at all times. ASIC must also be notified of any RM changes. Where the RM is named as a key person on the AFS licence, the licensee must, in the first instance notify ASIC, within five business days, of the actions it will take to replace that key person. RG 146 ASIC has specified minimum training standards for representatives (and natural person licensees) who provide financial product advice to retail clients. These are set out in RG 146 Licensing: Training of financial product advisers. The process of monitoring representatives is an opportunity to educate representatives about compliance procedures and to seek feedback for improvement. It also provides information about the effectiveness of the licensee’s compliance system in addressing compliance risks. With the introduction of the Financial Adviser Standards and Ethics Authority (FASEA) regime (¶8-260), RG 146 does not apply to new advisers post 1 January 2019. External auditor obligations External auditors now have to comply with new obligations to report certain matters. RG 34 was updated to include Australian financial services licensees in auditors’ guidance procedures. Previously, guidance for auditors was only offered to those auditing companies and registered schemes. According to the Corporations Act (under s 311 and 601HG), auditors must notify ASIC within 28 days of suspected contraventions of the Corporations Act. Auditors of AFS licensees must (under s 990K) report, within seven days, any entity with a suspected contravention of the Corporations Act. Financial Services and Credit Panel There are currently a number of peer review bodies in Australia including the Markets Disciplinary Panel (MDP), the Takeovers Panel and the Companies Auditors Disciplinary Board. In April 2017, ASIC released a consultation paper on its proposal to develop and implement a Financial Services Panel (the Panel). Following submissions, ASIC issued Report 551 Response to submissions on CP281 Financial Services Panel and established the Financial Services and Credit Panel. ASIC Regulatory Guide 263 sets out the principles and processes of this Panel. The Panel is responsible for determining whether ASIC should ban individuals from the financial services and credit industries for misconduct. ASIC would select matters and refer them to the Panel where they are significant, complex or novel. Members of the Panel are appointed by ASIC and comprise a pool of industry participants with relevant

expertise in the financial services or credit fields. The Panel sits alongside ASIC’s existing administrative processes and adds an element of peer review to ASIC’s decisions. Protections for “whistleblowers” reporting non-compliance Individuals (eligible whistleblowers) are protected under the Corporations Act (Pt 9.4AAA, as amended by the Treasury Laws Amendment (Enhancing Whistleblower Protections) Act 2019) when they disclose, to ASIC, APRA or other prescribed eligible recipients, information indicating that a regulated entity, officer or employee of the regulated entity has engaged in conduct that breaches the Corporations Act or other financial sector laws enforced by ASIC or APRA. Protections include maintaining the confidentiality of the eligible whistleblower, except in prescribed circumstances; protections from civil, criminal and administrative liability in relation to the disclosure; and protection from conduct (including threatened conduct) that causes detriment to the eligible whistleblower or another person, eg dismissal, harassment, intimidation, discrimination, and damage to a person’s property, business or financial position. Breaching the confidentiality of an eligible whistleblower’s identity and causing detriment are punishable offences that may result in criminal and pecuniary penalties. “Eligible whistleblower” is defined broadly in the Corporations Act s 1317AAA to capture a range of people including a past or present employee, officer, individual contractor, employee of a contractor or associate to the regulated entity. This would cover an employee or contractor of a regulated entity that provides advice on financial services. The whistleblower protection regime provides a significant means of combatting poor compliance by ensuring that companies, officers and employees know that misconduct can be reported and that those reporting the misconduct are protected.

¶8-020 The legislative framework for the financial system Financial advisers play a key role in the integrity and operation of the financial system, which has resulted in the industry being heavily regulated for the public’s benefit. A turning point came with the commencement of the FSRA in 2001 which amended the Corporations Act. For a detailed discussion on the financial services reform, see ¶8-220 to ¶8-350. The Future of Financial Advice reforms (FOFA reforms) The financial planning industry continues to be subject to constant regulatory change. The collapse of several financial product providers prompted the government to launch an inquiry into financial products and services during 2009 (the “Rippoll” inquiry). In response to the inquiry, the government released the FOFA reforms package in April 2010 which it legislated. Many of the reforms commenced on 1 July 2013. The FOFA reforms were the most significant changes to the way advice is provided to retail clients since the introduction of the FSRA. They change the landscape of the provision of advice and how financial products are recommended to clients. In summary, the major FOFA measures are as follows: • A prospective ban on upfront and trailing commissions and like payments for commission under risk insurance products within superannuation where no personal financial advice has been provided, that is, where cover has been provided under a default superannuation fund (ie MySuper products) and group risk within superannuation. Note that this ban does not apply to individual pure risk insurance, whether in superannuation or otherwise. • A prospective requirement for advisers to get clients to opt-in or renew their advice agreement every two years. • A prospective ban on any form of payment relating to volume or sales targets from any financial services business to dealer groups, authorised representatives or advisers, including volume rebates from platform providers to dealer groups for preferential treatment of certain products on the platform. The ban extends to employee remuneration calculated based on sales and volume targets. A limited

exemption applies to employees of a bank advising on and selling basic banking products. • Grandfathering measures exist to protect certain arrangements that were in place before FOFA commenced on 1 July 2013, including: – the purchase and sale of financial planning businesses within the same licensee – the grandfathering of commissions and volume bonuses – employer and employee arrangements – reinstating arrangements that were terminated as consequence of FOFA. • Further regulations were introduced in 2014 that amended the grandfathering arrangements to allow authorised representatives to move licensees, the buying/selling of client books, and retaining grandfathered benefits. • A prospective ban on soft dollar benefits, where a benefit is $300 or more (per benefit). The ban does not apply to any benefit provided for the purposes of professional development and administrative IT services if set criteria are met. • Percentage-based fees (known as assets under management fees) will only be able to be charged on ungeared products or investment amounts. • The introduction of a statutory best interests duty, requiring advisers to act in the best interests of clients and give priority to the interests of the client above any other interests. Compliance with this duty will be measured according to what is reasonable in the circumstances in which advice is provided. • The introduction of a new form of limited advice called “scaled advice” which can be provided by a range of advice providers, including superannuation trustees, financial planners and potentially accountants. Regulations have clarified the requirement regarding scaled advice complying with the best interest obligations and provide that clients and advisers can explicitly agree on the scope of financial advice to be provided. It is still necessary for the adviser to ensure that the advice to be provided is appropriate for the client. However, this does not mean a client can simply “buy the advice” they want if it is not appropriate for them in the adviser’s view. It is important that advisers carefully consider specific requests from clients for particular advice and only provide it if it is in their opinion appropriate for the client’s circumstances. Note in particular that the “catch-all” provision under s 961B(2)(g) of the Corporations Act may require the adviser to consider circumstances outside the scoped advice. • Strengthening the powers of ASIC in relation to the licensing and banning of individuals from the financial services industry. The government has announced that grandfathered remuneration will be banned from 1 January 2021. Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry was established in December 2017. The Commission heard issues of poor customer outcomes across lending, financial advice, superannuation and insurance, particularly across the big four banks and AMP and looked at the conduct of the key regulators being the Australian Prudential Regulation Authority (APRA) and ASIC. The Final Report was released in February 2019 and contained 76 recommendations across the banking, financial advice, superannuation and insurance sectors as well as in relation to ASIC and APRA. Twentyfour referrals were issued for potential criminal prosecution. The Final Report explored:

• the issues identified by the Commission • causes of those issues • responses and recommendations. The issues identified relating to financial advice included: • culture and incentives — including issues about the culture of particular parts of the financial services industry, such as mortgage brokers, financial advisers, and point of sale agents for consumer lending. • conflicts of interest and duty, and confusion of roles — consideration of structural considerations and the impact of vertical integration (in the sense that the entity manufactures and sells financial products while, at the same time, advising clients which products to use or buy) • regulator effectiveness — what responses regulators can make, and what responses regulators should make, to financial services misconduct. Regarding financial advice, the Commission made the following recommendations: Rec 2.1 — Annual renewal and payment • Two year opt-in requirement to change. • Ongoing Fee Arrangements (OFAs) must be in writing and reviewed annually by clients. • OFAs must record in writing each year the services that the client will be entitled to receive and the total of the fees that are to be charged. • Payment requires client’s express written authority to the entity that conducts the account at or immediately after the latest renewal or an OFA. • These requirements are to apply to all clients including pre-FOFA clients. Rec 2.2 — Disclosure of lack of independence • Advisers are to provide retail clients with a written statement explaining why the adviser is not independent, impartial and unbiased before providing personal advice, unless the adviser is allowed to use those terms under s 923A of the Corporations Act. Rec 2.3 — Review of measures to improve the quality of advice • By no later than 31 December 2022, the government in consultation with ASIC is to review the effectiveness of measures that have been implemented by the government, regulators and financial services entities to improve the quality of financial advice. • The safe harbour provision in s 961B(2) Corporations Act to be reviewed. The recommendation is to repeal the Safe Harbour provision if it is found to be unnecessary. Rec 2.4 — Grandfathered commissions • The government will seek to end grandfathering of conflicted remuneration from 1 January 2021. • Government committed to ensuring payments of any previously grandfathered arrangements are rebated to clients and passed on in terms of fee savings. • ASIC will monitor and report to government on the extent to which product providers are acting to end grandfathering during the period 1 July 2019 to 1 January 2021. Rec 2.5 — Life risk insurance commissions

• A recommendation to further reduce the cap of life insurance commissions with view to going to zero. • The government has committed to review of the Life Insurance Framework (LIF) in 2021. • If no evidence of significant improvement in quality of advice, the government will seek to mandate level commissions as recommended by the Financial System Inquiry (FSI). Rec 2.7 Reference checking and information sharing and Rec 2.8 Reporting compliance concerns • The government will seek to mandate reference checking and information-sharing protocol for financial advisers for all AFSL holders to make it more difficult for bad apples to find alternative employment in the industry. • The government will mandate reporting of “serious compliance concerns” about individual financial advisers to ASIC on a quarterly basis. The Royal Commission highlighted concerns around the current reporting of breach information to ASIC with firms failing to report significant breaches to ASIC in a timely manner. In response to Rec 7.2 (Implementation of recommendations), the government will strengthen the breach reporting requirements. Rec 2.9 — Misconduct by financial advisers • The government will require all AFSL holders to make whatever inquiries reasonably necessary to determine the nature and full extent of an adviser’s misconduct (when the licensee detects misconduct) and inform and remediate affected clients promptly. Rec 2.10 — A new disciplinary system • Recommendation that the law should be amended to establish a new disciplinary system for financial advisers that: – requires all financial advisers who provide personal financial advice to retail clients to be registered – provides for a single, central, disciplinary body – requires AFSL holders to report “serious compliance concerns” to the disciplinary body, and – allows clients and other stakeholders to report information about the conduct of financial advisers to the disciplinary body. • The government will seek to bring advisers in line with other professions — such as lawyers, doctors and accountants — where individual registration is standard practice. • A proposed disciplinary system would operate concurrently with the existing AFSL regime and ASIC will retain the powers it has under the current regulatory framework. The Commission also looked closely at the regulators and made the following recommendations: Rec 6.1 — Retain “Twin Peaks” model and Rec 6.4 — ASIC as conduct regulator • The government is in favour of retaining the current system where responsibility for conduct and disclosure regulation lies primarily with ASIC and responsibility for prudential regulation with APRA. • APRA is still regulator of the Superannuation Industry (Supervision) Act 1993 (SIS Act) for public offer funds (and the Australian Taxation Office (ATO) for SMSFs) but ASIC will enforce civil penalty provisions against Registered Superannuation Entity (RSE) directors. Rec 6.2 — ASIC’s approach to enforcement • The government supports adoption of the Royal Commission’s recommendation and will build on

changes already underway within ASIC, both with its recent shift to a “why not litigate” stance, and recommended changes to its policies, processes and procedures put forward by its recent internal review of enforcement. Rec 6.6 — Joint administration of the BEAR and Rec 6.8 — Extending the BEAR • APRA and ASIC to jointly administer consumer protection and market conduct matters. • BEAR to be extended over time to include superannuation fund trustees and insurance companies. Rec 6.9 — Statutory obligation to co-operate and Rec 6.14 — A new oversight authority • APRA and ASIC will have a statutory obligation to co-operate with each other and have oversight. Rec 7.1 — Compensation scheme of last resort (CSLR) • The government will establish an industry funded, forward-looking CSLR. • A recommendation to ensure that where consumers and small businesses have suffered detriment due to failures by financial firms to meet their obligations, compensation that is awarded is actually paid. • The CSLR will operate as a last resort mechanism to pay out compensation owed to consumers and small businesses that receive a court or tribunal decision in their favour or a determination from AFCA, but are unable to get the compensation owed by the financial firm — for example, because the firm has become insolvent. The CSLR will be established as part of the AFCA. • The government will also require AFCA to consider disputes dating back to 1 January 2008 — the period looked at by the Royal Commission, if the dispute falls within AFCA’s thresholds as they stand today. Draft legislation has been prepared for the majority of the recommendations with the main exception being some of the recommendations relating to remuneration practices in the mortgage broking industry. The start date of some of the measures (such as a move to annual renewal notice for ongoing adviser fees) has been delayed to 1 January 2021 and for others to 30 June 2021 due to the economic impacts of COVID-19. Other measures that took effect immediately included AFCA opening the door to legacy complaints dating back to 1 January 2008 (which is a great deal longer than the statute of limitations on financial complaints under AFCA’s rules).

Tip Reflect and consider the comments contained in the final report regarding sections of the legislation that may be breached by certain behaviour as it is likely that these will be targeted by ASIC in the future.

ASIC Regulatory Guides In order to assist licensees in meeting their regulatory obligations, ASIC has issued regulatory guidance on various aspects of the FOFA reforms, in particular: • best interests duty (RG 175: updated March 2017) • giving information, general advice and scaled advice (RG 244) • conflicted remuneration (RG 246)

• its amended licensing and banning powers (updated RG 98) • its approach to the approval of codes in the financial advisory sector (RG 183), and • fee disclosure (RG 245). ASIC’s amended licensing and banning powers commenced on 1 July 2012 and the remaining FOFA reforms came into effect on 1 July 2013.

Tip Some positive aspects of regulating financial advisers are: – the public can seek advice with greater confidence, leading to a greater demand for financial advice – new training requirements mean that the necessary educational requirements are met – clients will have access to a better range of products – regulating the sales process can result in a greater variety of sales than might occur without regulation.

Providing entity A concept of a providing entity has been introduced under FOFA. The conduct and disclosure obligations in Pt 7.7 apply to “providing entities”. Providing entities may be AFS licensees or authorised representatives. Representatives that are not authorised representatives are not providing entities. Where a licensee provides financial product advice (eg through one of its employees), the licensee is the providing entity. Where an authorised representative provides financial product advice, the authorised representative is the providing entity. A licensee needs to ensure authorised representatives provide advice in accordance with the law (RG 175.35). Regulation by the Corporations Act This Act governs the licensing of those engaged in the advice and dealing of financial products. This Act consists of the Act itself and its regulations. There are also a series of RGs issued by ASIC, which administer the Act. These can be found at www.asic.gov.au under the Financial Services tab in the Compliance-Resources section. Common Law obligations (RG 175.70) Common law provisions also apply to the provision of advice. These include: (a) a duty to disclose conflicts of interest (b) a duty to adopt due care, diligence and competence in preparing advice (c) fiduciary duties. Regulation under the Life Insurance Code The Life Insurance Code no longer exists. Life insurance products are now a financial product (¶8-220) under the Corporations Act with advice and sale of life insurance products now governed by the Corporations Act.

General insurance The giving of financial advice at times will involve general insurance. For example, adequate protection of the family home, car or other assets can be a central part of assessing the client’s risk management needs. There is a General Insurance Code of Practice aimed at increasing standards in that industry, without prescribing advising and sales processes. It is administered by the Insurance Council of Australia, and is, in effect, legally binding on members of that industry. General insurance products are now also a financial product (¶8-220) under the Corporations Act with advice and sale of general insurance products now governed by the Corporations Act, however, general insurance products are excluded from the FOFA reforms. Key reporting obligations under AFSL regime Obligation

Requirement

Due date for lodgment

Breaches and events

Notification of breach of AFS licensee’s general obligations or compensation arrangements

As soon as practicable but within 10 business days

Notification of any event that may make a material adverse change to the licensee’s financial position

Within three business days

Notification of change in control of the licensee

Within 10 business days

Notification of change in licensee’s: – name – principal business address – Australian Business Number (ABN) – responsible managers – dispute resolution – compensation details

Change of name within 14 days, other changes within 10 business days

– notification of change of “key person” named on the licence – variation to authorisations and other conditions of an AFSL

Within five business days Lodged with ASIC for approval as required

Notification of authorising a representative

Within 15 business days

Notification of revocation of authorised representative

Within 10 business days

Notification of change in authorised representative’s name, principal business address, directors (if a company) or ABN

Within 10 business days

Lodge financial statement and audit report

Within three months of end of financial year

Change in licensee’s particulars

Authorised representatives

Financial statements and audit

BEST PRACTICE ¶8-100 Overview of financial adviser best practice To ensure advisers act ethically and in their client’s best interests at all times, it is necessary to adopt

“best practice” principles. Generally, this means performing fiduciary and compliance duties and adopting certain business practices. FOFA has introduced statutory provisions relating to advice; however, this does not override the common law provisions. The statutory provisions should be viewed as a minimum standard. A summary of the best practice principles that an adviser should employ has been provided at ¶8-110. This aims to give advisers practical assistance with compliance regarding their everyday business activities. A good rule of thumb is to always put the interests of the client first.

¶8-110 Key elements of best practice

Checklist To provide best practice, advisers need to apply the following: ☑ fiduciary duty and best interest duty (¶8-120) ☑ quality advice, documents and record keeping (¶8-130) ☑ act efficiently, honestly and fairly (¶8-140) ☑ disclosure to the client (¶8-150) ☑ professional Codes and Standards (¶8-170) ☑ competencies, experience and training (¶8-180) ☑ supervision and written directions (¶8-190) ☑ avoiding giving the wrong impression (¶8-405) ☑ avoiding unfair conduct (¶8-410) ☑ Competition and Consumer Act requirements (¶8-415) ☑ privacy (¶8-510) ☑ compliance with the law and ASIC directives ☑ oral advice — this is permitted in cases of urgency but must be confirmed in writing ☑ avoiding undue influence — the decision must be the client’s own, and not influenced by any other person. If in doubt, the adviser should speak to the client alone ☑ ensure that they put the client’s interests ahead of their own ☑ subsequent service — the adviser should give efficient ongoing service with the client’s affairs. The review services offered should be clearly identified to the client.

The key elements of best practice are described below in more detail.

¶8-120 Duty to act in client’s best interest Advisers must act objectively and solely in their client’s best interests. The general law fiduciary duty (¶8010) to place the client first and disregard one’s own interest is the core basis for financial advising.

Failure to act in this way places the adviser’s authority and goodwill in jeopardy. The FOFA best interest duty does not replace these common law requirements. The “know-your-client” rule is an important aspect of the fiduciary or the proposed best interest duty. This rule ensures advisers fulfil their duties by giving advice that is appropriate to the client’s needs, financial circumstances, risk tolerance and aims. In other words, advisers must know a reasonable amount about their client’s financial needs before giving advice. To ensure advisers have a reasonable basis for advice, it is necessary to: • perform a detailed investigation and research the client’s needs • carefully record all relevant aspects • formulate clear advice for the client, and • obtain the client’s decision and implement it. From 1 July 2013, a statutory best interest duty came into effect for advisers. This is in addition to the obligation imposed on advisers under general law.

Tip Although the Corporations Act now contains specific requirements in relation to the provision of advice and the best interest duty under FOFA, neither overrides nor supersedes common law requirements relating to fiduciary duty.

Statutory best interest duty Under the FOFA reforms, the government introduced a statutory best interest duty for financial advisers which commenced on 1 July 2013. This is contained in s 961B(1) of the Corporations Act and ASIC’s further guidance in RG 175.199–RG 175.246. Advisers are required to act in the best interests of clients and give priority to the interests of the client above any other interests (including their own). Compliance with this duty will be measured according to what is reasonable in the circumstances and in compliance with s 961B of the Corporations Act. The best interest obligation enshrined in the Act also introduced seven “safe harbour” steps (see ¶8-125), the idea being that advisers who met each of the steps could demonstrate that they had met the requirement to act in their client’s best interest. The safe harbour provisions in s 961B(2) are listed below: (a) identify the client’s objectives, financial situation and needs (b) identify the subject matter of the advice and the objectives, financial situation and needs that would reasonably be considered as relevant to the advice sought (c) where it is reasonably apparent the information relating to the client’s circumstances was incomplete or inaccurate, make reasonable inquiries to obtain complete and accurate information (d) assess whether you have the expertise to advise on the subject and if you do not then decline the retainer (e) if in considering the subject matter of the advice it would be reasonable to recommend a financial product, reasonably investigate and assess products that might reasonably be considered as relevant to advice on the subject matter (f) base all judgments in advising the client on the client’s relevant circumstances

(g) take any other step that would reasonably be regarded as being in the best interests of the client given the client’s relevant circumstances. In the final report for the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, Commissioner Hayne argued that the FOFA reforms “emphasise process rather than outcome”. He considered that the legislated best interest duty was not a true fiduciary obligation because the best interest obligation could be met simply by following the safe harbour steps which are based on a reasonableness test rather than best practice professional outcome. He concluded that the focus on process could be counter-intuitive as it encourages advisers to adopt a “tick a box approach” to compliance. How does the FOFA best interest requirement interact with the FASEA Code of Ethics? The standards body, given authority under s 921X of the Act, to provide for improved standards of education, training, ethical behaviour and professionalism for relevant providers (financial planners and financial advisers) is the Financial Adviser Standards and Ethics Authority Ltd (FASEA). The acronym FASEA has come to represent not only the standards authority itself, but generally the Code of Ethics itself (FASEA Code, or Code) that all advisers must comply with from 1 January 2019 (s 921E). The Code takes the form of five broad values and 12 ethical and professional standards. Specific to the client’s best interest duty, Standard 2 (according to the explanatory statement) “requires, as an ethical duty, that you [the adviser] act with integrity. It also requires you to act in the best interests of each client”. At 29 of the explanatory statement, “You act in a client’s best interests if what you do — the advice you give, the products and services you recommend — are appropriate to meet the client’s objectives, financial situation and needs, taking into account the client’s broader, long-term interests and likely future circumstances. The test is, in short: will your advice and recommendations improve the client’s financial well-being?” The explanatory statement goes on to say (at 31) that, “the ethical duty in Standard 2 to act with integrity is a broad ethical obligation. It is based on a more professional relationship between the relevant provider and the client, where the relevant provider has a duty to look more widely at what the client’s interests are” and points out (at 34) that “the ethical duty in Standard 2 to act in the client’s best interests is not identical to the duty in section 961B of the Act. Sections 961B(2) to (4) describe a series of steps that a relevant provider may take; if those steps are taken, the relevant provider will have satisfied the ‘good faith’ duty in section 961B(1). This Code does not have any equivalent provisions. So, even if you follow the steps set out in section 961B of the Act, you may still not have complied with the duty under the Code to act in the client’s best interests”. And so we have an interesting juxtaposition of two very different legislative approaches that seek to elicit behaviours such as integrity, honesty and openness where an adviser truly puts the needs of their client ahead of their own, as one would expect of a fiduciary relationship. The FASEA Code does this by drawing on a higher, overarching ethical and professional obligation to act in the best interests of a client whereas, as described above, the FOFA requirement is based more on the adviser completing series of steps that, if appropriately satisfied, means the adviser can demonstrate they have acted “in good faith” and achieved safe harbour. Achieving safe harbour The best interest duty seems simpler in how it is presented and goes further than ASIC requirements and the safe harbour steps in s 961B of the Corporations Act which are levelled at the “reasonableness” test. For example, it would reasonably be regarded as in the best interests of the client to take a step, if a person with a reasonable level of expertise in the subject matter of the advice that has been sought by the client, exercising care and objectively assessing the client’s relevant circumstances, would regard it as in the best interests of the client, given the client’s relevant circumstances, to take that step. ASIC has issued an updated RG 175 on its interpretation of this best interest duty. ASIC has indicated that it believes “a reasonable advice provider would believe that the client is likely to be in a better position if the client follows the advice” (RG 175.229). In assessing the behaviour of an adviser and ensuring their actions are in the best interest of clients, s

961B and 961E apply the following four standards: 1. The adviser must have acted with a reasonable level of expertise in the subject matter of the advice sought by the client. 2. They must have exercised care. 3. They must have objectively assessed the client’s relevant circumstances. 4. They must have regarded taking the step as in the best interest of the client, given the client’s relevant circumstances. It should also be noted that the best interest duty in s 961B works in conjunction with related obligations in the law: • Section 961G, which requires the advice to be appropriate • Section 961H, which requires an adviser to provide a warning if there is any incomplete or inaccurate information • Section 961J, which requires an adviser to prioritise their client’s interests ahead of their own, and • Section 961L, which requires licensees to ensure that their representatives are complying with these sections. Modified best interests duty An employee or agent of an ADI providing advice on a consumer credit insurance product at the same time as providing advice on a basic banking product and/or a general insurance product will only need to follow the modified best interests duty safe harbour steps in relation to the basic banking product and/or a general insurance product (¶8-125). All best interest duty safe harbour steps must be followed in relation to the consumer credit insurance. ASIC’s first “best interests” duty court case The Federal Court found that a financial advice firm (the Firm) had breached the best interests obligations of the Corporations Act FOFA (ASIC v NSG(2017) 35 ACLC ¶17-005; [2017] FCA 345). This was the first finding of liability against a licensee for a breach of the FOFA reforms. This matter related to financial advice provided by the Firm’s advisers on eight specific occasions between July 2013 and August 2015. On these occasions, clients were sold insurance and/or advised to rollover superannuation accounts that committed them to costly, unsuitable, and unnecessary financial arrangements. The Firm consented to the making of declarations against it and after a hearing on 30 March 2017 the court was satisfied that declarations ought to be made. The court found that the Firm’s representatives: • breached s 961B of the Corporations Act by failing to take reasonable steps to ensure that they provided advice that complied with the best interests obligations, and • breached s 961G of the Corporations Act by failing to take reasonable steps to ensure that they provided advice that was appropriate to its clients. Those breaches amounted to a contravention by the Firm of s 961L of the Corporations Act, which provides that a financial services licensee must ensure its representatives are compliant with the above sections of the Act. The court made the declarations based on the following deficiencies in the Firm’s processes and procedures: • the Firm’s new client advice process was insufficient to ensure that all necessary information was

obtained from, and given to, the client • the Firm’s training on legal and regulatory obligations was insufficient to ensure clients received advice which was in their best interests • the Firm did not routinely monitor its representatives nor identify deficiencies in the knowledge or skills of individual representatives • the Firm did not conduct regular or substantive performance reviews of its representatives • the Firm’s compliance policies were inadequate, and did not address its representatives’ legal or regulatory duties, and in any event, were not followed or enforced by the Firm • there was an absence of regular internal audits, and the external audits conducted identified issues which were not adequately addressed nor recommended changes implemented, and • the Firm had a “commission only” remuneration model, which meant that representatives would only be compensated by way of commission for sales of life insurance products and superannuation rollovers. ASIC Deputy Chair, at the time, Peter Kell indicated: “This finding, the first of its kind, provides guidance to the industry about what is required of licensees to ensure representatives comply with their obligations to act in the best interests of clients and provide advice that is appropriate”. In October 2017, the firm was fined $1m for their breaches of the best interests duty. This was the first civil penalty imposed on a financial services licensee for breaches of the best interests duty. What does this mean for advice firms? It is important that advice firms have robust processes that are designed to ensure a proper fact-finding process that considers all relevant factors are in place. The case highlighted that a “sales process” which focuses on uninformed decision-making and having clients acquire a financial product as soon as possible without engagement and understanding, is flawed. The court case also indicates a need for licensees to better manage conflicts of interests in relation to commissions received. The Firm’s commission-based model led to breaches of the best interest duty and a conflict of interest by not prioritising the client’s interests over its own.

Tip Ensure that all advice given prioritises the interests of the client and meets the “safe harbour” requirements.

¶8-125 Duty to give appropriate advice What is appropriate advice under FOFA? Appropriate advice is defined in s 961G of Corporations Act and ASIC has provided further guidance in RG 175.341–RG 175.348. ASIC has provided a checklist in Appendix 3 of REP 515 “Financial advice: Review of how large institutions oversee their advisers” that is useful in determining appropriate circumstances of a client.

Checklist In providing appropriate advice, it is necessary for an adviser to consider the following in respect of the relevant circumstances of each client: ☑ establish the client’s relevant circumstances and clearly scope out the advice to be provided, including assisting the client to set measurable prioritised goals and objectives. ☑ investigate the client’s circumstances as it applies to the scope of the advice and provide a warning where any information is incomplete. ☑ consider all potential strategies and options available and then determine the most appropriate strategy for the client, ensuring that, where relevant, aspects such as tax and social security have been considered. ☑ determine an appropriate product recommendation that meets the client’s recommended strategy. The product recommendation should be the means by which the recommended strategy is achieved, ie the “means to the end” and not the “end” in itself. ☑ set out the advice in a clear and logically structured Statement of Advice (SoA) that clearly sets out the benefits to the client of the recommendations and how it places the client in a better position, ensuring priority is always given to the client’s best interest. ☑ complete a “safe harbour” checklist. ☑ present the SoA to the client and explain the advice in an understandable manner with verbal interaction with the client to ensure that they understand the advice and recommendations given. ☑ document any verbal interaction in a file note. ☑ provide a clear explanation to any questions the client may have and revise the advice provided if necessary.

Advice not meeting best interest is unlikely to be appropriate ASIC has indicated in RG 175.343 that advice not meeting best interest is unlikely to be appropriate. Ultimately it will be the courts which will determine how this plays out.

Tip Licensees should ensure that they have robust processes to ensure the advice provided is in the best interest of its clients.

Advice does not need to be perfect While the list above is comprehensive, there is no unique perfect solution to a client’s financial circumstances and objectives and all that an adviser can do is provide appropriate advice. This aspect is also recognised in RG 175.227 which states that ASIC does not expect an advice provider to give “perfect advice” to establish that the client is in a better position if the client follows the advice. It is to be noted, however, that the “better position” identified by ASIC is not contained in the relevant legislation and is an interpretation added by ASIC in its regulatory guide.

It should be self-evident to advisers that they need to always present advice that leaves their client in a better position following implementation of that advice. An example of where an adviser might not put the client into a better position is a recommendation to switch from one product to another which has a lower fee. However, if the adviser saves the client 30 basis points on the new product but charges the client 1.0% per annum of the value of the funds invested (referred to as Funds Under Advice or FUA) in ongoing fees that they weren’t paying before, the client is not, in reality, in a better position. Another example might be where a recommendation to sell down an existing investment to then reinvest in another investment crystallises a material capital gains tax liability, which, when added together with the transaction costs, may take longer than the recommended investment time horizon to see any potential gain from the product switch. ASIC’s guidance in relation to investment performance (RG 175.224 to RG 175.231) In providing advice, advisers would naturally try to ensure that a client is left in a better position than they would have been had they not followed the advice. This is to be assessed at the time the advice was given and not with the benefit of hindsight. ASIC has commented specifically in this regard to investment performance, stating that they will not examine investment performance retrospectively, with the benefit of hindsight (RG 175.231). It should be noted that this term is only contained in ASIC’s Regulatory Guides and is not part of the relevant legislation. Notwithstanding this, it is good practice to always ensure that advice provided will leave clients in a better position. Penalty regime A client, or ASIC, may take civil action for any loss or damage suffered as the result of a failure to comply with the best interests duty and related obligations. The Treasury Laws Amendment (Strengthening Corporate and Financial Sector Penalties) Act 2019 introduced a new penalty regime from March 2019 and significantly increased the maximum penalties for individuals and companies ($200,000 for individuals and $1m for companies). For individuals, the financial penalty is the greater of: • 5,000 penalty units ($1.11m), or • three times the benefit derived or detriment avoided by the contravention. For companies, the financial penalty is the greater of: • 50,000 penalty units ($11.1m), or • three times the value of the benefit obtained or detriment avoided by the contravention, or • 10% of the company's annual turnover (capped at a maximum of 2.5 million penalty units, which is currently $555m). The number of provisions which are subject to the civil penalty regime has been expanded with a number of additional provisions in the Corporations Act, as well as other provisions included in the Credit Act, Credit Code and the Insurance Contracts Act. This includes: • the general licensee obligations under s 912A (including to do all things necessary to ensure the financial services are provided efficiently, honestly and fairly and the obligation to manage conflicts of interest, to have adequate resources and competency, and to have in place adequate compliance and risk management arrangements) • provisions relating to the handling of client money, and • breach reporting obligations under s 912D of the Corporations Act.

For several offences under the Corporations Act, ASIC Act and the Credit Act, the maximum imprisonment term has also been increased. • For the most serious offences under the Corporations Act (eg false trading, market rigging and making false and misleading statements under s 1041B and 1041E of the Corporations Act), the maximum term has been increased from 5 to 15 years. Fines for offences were increased with a new formula introduced to calculate financial penalties with the maximum financial penalty now calculated by reference to the maximum term of imprisonment for the relevant offence. For offences where the maximum term of imprisonment is 10 years or more (such as false trading and market rigging and making false and misleading statements under s 1041B and 1041E of the Corporations Act). For individuals, the maximum financial penalty for individuals is the greater of: • 4,500 penalty units ($999,000), or • three times the benefit derived or the detriment that was avoided by the contravention. For companies, the maximum financial penalty is the greater of: • 45,000 penalty units ($9.99m), or • three times the benefit derived or the detriment that was avoided by the contravention, or • 10% of the company's annual turnover. This penalty applicable to an offence is not capped. For strict liability offences (such as failing to provide notice of name and address of directors and secretaries to ASIC), imprisonment has been removed as a punishment and replaced with increased financial penalties. Relinquishment orders, also known as disgorgement remedies, were previously only available in criminal matters under the Proceeds of Crime Act 2002. These are now included in civil penalty proceedings brought by ASIC under the Corporations Act, the Credit Act and the ASIC Act. Provisions have also been included to ensure that where civil penalty provisions are breached, courts are to give preference to making a compensation order where the defendant does not have sufficient financial resources to pay a financial penalty and a relinquishment order. Infringement notices can now be imposed by ASIC for contraventions of the unconscionable conduct and consumer protection provisions of the ASIC Act and the strict liability offences and civil penalty provisions under the Credit Act. Until this Act came into force there was no consistent definition of “dishonesty” for the purposes of offences in the Corporations Act. A new definition of dishonesty was introduced and applies to all dishonesty offences under the Corporations Act. The new definition sets out that conduct is dishonest if according to the standards of ordinary people it was dishonest (the “pub test”). It is no longer a requirement for the person involved in the conduct to know it was dishonest according to the standards of ordinary people. Thus, it is possible for someone to engage in dishonest conduct without knowing that the conduct was dishonest. In addition, ASIC will be able to seek additional remedies to strip wrongdoers of profits illegally obtained, or losses avoided from contraventions resulting in civil penalty proceedings.

¶8-130 The pre-FASEA, pre-FOFA duty to give quality advice Prior to 1 July 2013 The obligation to provide quality advice set out in s 945A was based on two key elements: (1) the suitability rule, and

(2) informed consent. The suitability rule is effectively the reasonable basis rule or the “know-your-client” and “know-yourproduct” rule. This required: • sufficient client inquiries of the customers’ personal circumstances (eg clients’ objectives, financial situation and needs) • consideration of the customers’ personal circumstances • addressing and satisfying the customers’ needs. This required consideration of the strategies and products available • advising the customer what other services they need to explore. This can occur when specialist advice is also required (eg estate planning) or telling the client that their needs cannot be addressed • addressing the clients’ tolerance of risk. Informed consent required that the advice was communicated in a clear and concise way, so that the client fully understood the advice given and provided consent with the full knowledge of that advice. This required that the advice was not misleading, deceptive, incomplete or provided in a pressured environment. The “know-your-client, know-your-product” rule meant that when an adviser was providing personal advice to a retail client it was important to ensure that the personal advice provided was fit for its purpose and appropriate in all the circumstances. IN 2011, the guidance from ASIC suggested that personal advice did not need to be ideal, perfect or best but it had to satisfy each of the following three elements to be considered suitable (reproduced from ASIC’s RG 175, issued 1 April 2011): (a) the providing entity had to make reasonable inquiries about the client’s relevant personal circumstances (b) the providing entity had to give such consideration to, and conduct such investigation of, the subject matter of the advice as was reasonable in all the circumstances (c) the advice had to be “appropriate” for the client.

Note The “suitability” rule applied to personal advice but not to general advice. The requirement to do this is now included as part of the law; consequently, failure to do this is an offence under the Corporations Act.

How to assess quality? Quality of advice is by its very nature subjective. However, it is the hallmark of distinguishing financial planning as a profession.

Checklist Assessment of quality can be measured by: ☑ determining whether the strategy was based on a “formula approach” or was it tailored to the client?

☑ considering the alternatives. Was the strategy based around the revenue earned or what was best for the client? ☑ asking whether if another adviser examined the client file and advice provided, they would conclude that it was in the client’s best interest? ☑ asking would the strategy pass an external compliance review? ☑ ascertaining if there were any shortcuts taken. ☑ the nature of customer complaints. Do they often refer to not understanding the advice or that it did not address their needs?

Checklist In summary, good quality advice: ☑ meets the client’s needs, as well as satisfying the law ☑ refines and clarifies the client’s objectives, and helps the client to achieve those objectives ☑ can be comprehensive or limited in scope (noting that under FASEA, the adviser has broader obligations to consider all of the client’s information and relevant needs) ☑ educates clients to make informed decisions about their finances ☑ is based on sound strategic advice ☑ has product recommendations that follow, rather than direct, suggested strategies ☑ involves good communication, which is honest and does not avoid difficult issues ☑ puts the client’s interests first.

Tip • Look at advice processes and make sure they facilitate good quality advice. • Tailor incentives to recognise quality advice provided. • Ensure advice is relevant to each client’s circumstances and in their best interest. • Do not rely on client evaluations as a test of quality. • Provide ongoing periodic training and professional development.

Documents The client is entitled to receive their adviser’s written advice, and copies of the Statement of Advice (SoA) at any time. The client is not entitled to receive any research undertaken by the adviser.

Tip All documents given to the adviser by the client remain the client’s property and should be carefully and securely preserved.

Why documentation is so important ASIC considers documentation to be a critical part of compliance as it allows the licensee and the advisers to demonstrate that they are complying with the financial services laws. Adequate documentation will be necessary to demonstrate that “safe harbour” provisions have been met in order to rely on the “safe harbour” defence. (RG 175.250 sets out all elements that need to be met.) Record keeping by licensees Licensees must keep records for at least seven years from the date that personal advice is provided to a retail client. Records may be kept electronically. In order to satisfy and rely on the safe harbour provisions, it will be necessary to keep accurate and complete records and also to assist in defending a claim that they have breached their obligations under Div 2 of Pt 7.7A. In particular, it is important to prepare and keep on file detailed file notes of any discussion with the client either preceding the preparation of the SoA or afterwards in discussions during presentation of the SoA. ASIC has now provided some guidance in RG 175.400 as to what constitutes records. Records may take various forms, and do not have to be paper-based, for example, they may include: • the advice document, that is, the SoA • file notes, including records of conversations • correspondence • working papers • fact-finding documents used when making inquiries into the client’s relevant circumstances • audio recordings • evidence of what compliance systems are used by the advice provider’s licensee or authorised representative. This includes: – training materials – records of who attended the training, and – call scripts, and • evidence of how the advice provider has complied with these systems. These records should be comprehensive and enable another adviser without any knowledge of the client to be able to validate the advice provided. It should be noted that ASIC has in the past banned an adviser for inadequate record keeping and SoA offences. The adviser was found to have failed to “maintain adequate records of his advice; provide an SoA within the required timeframe; provide an SoA that adequately set out information about the basis on which the advice was given; and provide appropriate replacement product advice”.

¶8-140 Duty to act efficiently, honestly and fairly

It is considered best practice that an adviser must act efficiently, honestly and fairly when providing financial advice. While these terms are not legally defined, common law applies. “Efficiently” means advisers are to carry on their business in an efficient manner. “Honestly” relates to ethics, fiduciary duties and codes of conduct and “fairly” means advisers are not to discriminate between clients. Part of this best practice principle is displaying high standards of integrity and openness in carrying out financial advising business.

¶8-150 Duty to disclose conflicts of interest Conflicts of interest Advisers need to make sure that they disclose anything that the client may see as being likely to affect the impartiality of their judgment and advice. The management of conflicts of interests are covered in RG 181 Licensing: Managing conflicts of interest. RG 181 sets out a general approach to compliance with the statutory obligation to manage conflicts of interest in s 912A(1)(i)(aa) (the conflicts management obligation). The RG provides guidance for licensees on: • controlling and avoiding conflicts of interest • disclosing conflicts of interest • complying with obligations • avoiding conflicts of interest if need be. Disclosure of conflicts of interests includes: • how advisers are remunerated • other benefits — soft dollar, that is, non-cash rewards • limitations on the products you can recommend • links with product providers • any sum that may be paid to third parties as a result of placing business. Note that certain remuneration structures have been banned from 1 July 2013 (¶8-155). Priority conflicts rule Under FOFA an advice provider must prioritise the interests of the client above their own or the interests of a related party (s 961J of the Corporations Act and ASIC guidance in RG 175.367–RG 175.382). Compare this to Standard 3 of the FASEA Code which says: “you must not advise, refer or act in any other manner where you have a conflict of interest or duty”. Under FOFA, if an advice provider with a conflict is unable to prioritise the client’s interests, they must not give the advice, but under FASEA, where the adviser encounters a conflict of interest or duty, they must disclose the conflict to the client and they must not act.

Tip The client has the right to know any issue that may be seen as having the potential to impact on the objectivity of the advice given.

ASIC launches first conflicted remuneration court case In June 2019, ASIC commenced civil proceedings in the Federal Court against a firm (RM Capital) which advised clients to set up self-managed superannuation funds (SMSFs) to buy real estate marketed by a particular agent and accepted more than $730,000 in conflicted remuneration. This is the first case that ASIC has initiated alleging breach of the conflicted remuneration provisions under the Corporations Act. ASIC is seeking declarations of contravention, civil penalties and compliance orders against the licensee and its authorised representative. Australian Securities & Investments Commission v R M Capital Pty Ltd ACN 065 412 820 & Anor

¶8-155 Disclosure of adviser remuneration (RG 246 “Conflicted Remuneration”) One of the most significant features of the FOFA reforms relates to the overhaul of adviser remuneration models, including the ban on commissions and volume-based bonuses. Percentage-based fees (also known as assets under management fees) are only chargeable on ungeared investment amounts. The ban also applies in relation to all financial products provided to retail clients, including managed investment schemes, superannuation, margin loans and to group life insurance products in all superannuation and to all risk insurance products within a default or MySuper product. It does not apply to individual risk insurance policies. There will also be a ban on soft dollar benefits in these areas. The following table provides a broad description of how payments are treated under FOFA. Form of remuneration Commission type benefits relating to provision of general advice

Permitted or prohibited Prohibited

Initial/upfront commission

Prohibited  There must be separate fees for the product and the advice 

Trail commission

Prohibited  There must be separate fees for the product and the advice 

Fee for service charged as an assetbased fee on ungeared products or investment amounts

Permitted

Fee for service charged as an assetbased fee on geared products or investment amounts

Prohibited

Other types of fees for service for advice (eg hourly rate, flat fee, fixed annual fee, performance-based fee)

Permitted

Volume-based bonus and fee rebate (paid by product provider to licensee or adviser)

Prohibited

Volume-based bonus dependent on the number or value of life insurance products

Prohibited

Volume-based payments or sales incentives (paid by licensees to adviser)

Prohibited

Volume-based shelf space fee (paid by fund manager to platform provider, and subsequently to licensee)

Prohibited

Shelf space fee (not based on volume that flows to and from the platform)

Permitted

Grandfathered commission Commissions given by a property developer to an adviser where the adviser recommends the establishment, or use, of an SMSF to purchase property

Permitted but will be banned from 1 January 2021 Likely to be conflicted remuneration — see ASIC launches first conflicted remuneration court case ¶8-150

Introduction of a fee disclosure adviser charging regime The FOFA reforms also introduced an adviser charging regime under which advisers were required to agree their fees directly with clients and disclose the charging structure to clients in a clear manner, including as far as practicable, total adviser charges payable, expressed in dollar terms. The FOFA reforms provided that from 1 July 2013, advisers were also required to get clients to opt-in or renew their advice agreement every two years. Advisers are only be able to charge ongoing advice fees if a payment plan has been agreed with the client, or if the charge relates to the provision of an ongoing service. This is generally achieved with the issue of a client service agreement (CSA) which stipulates the services to be provided, the terms on which those serves are provided and the fees the adviser will charge. If an adviser is to provide an ongoing service, the adviser must send a renewal notice to the client at least biennially. Ongoing fee arrangements — what level of service does the adviser need to provide to justify ongoing fees? Post FSRA and in the lead up to FOFA, investment and superannuation providers innovated to move away from commissions and allowed advisers to charge “adviser service fees” either in place of, or in addition to, product commissions. Advisers perceived “adviser service fees”, that were separately disclosed on products statements, to be more professional than a “commission” and started to offer differentiated services based on the level of fees charged. In fact, and prevailing post-FOFA, many advisers had large books of ongoing fees, sometimes in the many thousands of dollars per annum, subject to a CSA that outlined the applicable services to be provided as an “offer of a review”, “access to the adviser by email or phone”, “access to practice staff”, “access to the adviser’s website” and maybe a newsletter or economic update. ASIC’s “Report 499 (REP 499) Financial Advice: Fees for no service” (October 2016), Regulatory Guide 256 Client review and remediation conducted by advice licensees (RG 256) (September 2016) and Information Sheet (INFO) 232 (August 2018) made clear the legislated service requirements imposed upon AFS Licensees and their Authorised Representatives for all clients on Ongoing Fee Arrangements (OFAs). In these, ASIC has been very clear that to evidence that an annual review was provided, it is expected that advice is provided (noting that a hold recommendation is also advice) and as such, there should be evidence of a SoA or ROA. Additionally, ASIC states that when a client did not receive the annual review that they were entitled to, they should be paid compensation, with interest. In addition, it is pertinent to highlight the further ethical layer FASEA’s Code of Ethics has imposed upon authorised representatives, specifically in relation to integrity, as referenced in Standards 2, 3 and 8: • Standard 2, “You must act with integrity and in the best interest of each of your clients” and that “integrity requires openness, honesty and frankness in all dealings with clients” • Standard 3, “You must not advise, refer or act in any other manner where you have a conflict of interest or duty”, and

• Standard 8, “You must ensure that your records of clients, including former clients, are kept in a form that is complete and accurate”. Advisers are required to ensure that for all clients on OFAs: • annual reviews must be accompanied by an advice document (SoA or ROA), and • if an advice document has not been or will not be provided as part of a review, clients must be disengaged and fees refunded (with interest), as required. ASIC has been explicit that “if one cannot identify reliable evidence that the annual review was provided, we expect that it will refund the fees paid by the client. Each client should also receive interest, reflecting the lost investment returns on the fees that were inappropriately charged” (ASIC INFO 232, 2018). This has been a major shift for the advice industry where some advisers held onto ongoing fee arrangements without providing any services. The regulator has been very clear that they append most of the value of any ongoing fee arrangement to the provision of advice and the production of an advice document as part of an annual review. From its investigations, ASIC also noted that advice fees were being charged to superannuation members for extraneous services not always related to advice on the member’s superannuation account and issued a joint letter (Oversight of fees charged to members’ superannuation accounts) with APRA to superannuation trustees. In the letter, the regulators called upon superannuation trustees to have in place “strong governance, risk management and oversight processes to ensure that only authorised and appropriate fees and other charges are deducted from members’ superannuation accounts”. This accords with the recommendations from the Royal Commission which suggested, with regard to the payment of advice fees (recommendation 2.1), that “the law should be amended to provide that ongoing fee arrangements may neither permit nor require payment of fees from any account held for or on behalf of the client except on the client’s express written authority to the entity that conducts that account given at, or immediately after, the latest renewal of the ongoing fee arrangement”. The final report further recommended that (recommendation 3.3) “deduction of any advice fee (other than for intra-fund advice) from superannuation accounts other than MySuper accounts should be prohibited unless the requirements about annual renewal, prior written identification of service and provision of the client’s express written authority set out in Recommendation 2.1 in connection with ongoing fee arrangements are met”. Clients will still be able to pay for advice by having the fee deducted from their investment; however, the client must agree to the amount being deducted. Other disclosures Advisers must also: • accurately disclose to clients the capacity in which they operate, which includes identifying the relevant licensee • disclose the methods of remuneration for services (which may include fees payable by the client and should include all commissions, including trailer commissions) • disclose the relevant internal complaints system and external disputes resolution system, how they work, and how to access them • identify the services they can provide upfront to the client, and • not imply or hold out that they are licensees if they are not. Renewal notice and Fee Disclosure Statement The Act requires an adviser to send a renewal notice every two years to clients that have been signed to an ongoing advice and fee arrangement on, or after 1 July 2013 as well as all clients who received advice prior to the commencement of FOFA (1 July 2013) to “opt-in” to an ongoing fee arrangement to receive

further advice and services. The Fee Disclosure Statement A Fee Disclosure Statement (FDS) only needs to disclose the fees paid in the previous year, the services the client received in the previous year and the services the client was entitled to receive in the previous year. The FDS should set out in writing: • any Adviser Service Fees charged and paid in the previous 12 months in dollar amounts, and • information about the services available and actually received in this period.

Tip As flexibility exists to allow an FDS to be provided in a way that suits a particular adviser’s business, for example, reporting on the same day each year for all clients rather than on the anniversary of when they became clients, an adviser should determine and document how they intend to undertake this client reporting. It is not generally recommended that FDS and renewal notice dates be set on one day of the year as, depending on the efficacy of the adviser’s systems and processes, there may be a higher likelihood of being in breach of the requirements in s 962G and 962K if all services have not been provided for all clients as at that day.

The opt-in renewal notice The opt-in renewal notice must be in writing and include the following information. That the client: • may renew their ongoing fee and advice arrangement by giving you notice in writing within 60 days • must respond within the 60 days from the date of the renewal notice if they wish the advice arrangement to continue and that advice the arrangement will terminate, and no further advice will be provided or fee charged if they do not elect to renew the advice arrangement, and • has chosen to opt-out of the advice and that no further advice will be provided or will a fee be fee charged if they do not notify you in writing within 60 days that they wish the ongoing fee and advice arrangement to continue. If the client does not provide express notification, it means that the fee and advice arrangement will be terminated. It should also be noted that negative consent from the client (such as sending a renewal notice with a letter to the effect that if the client does not respond, it may be assumed that the client wants to retain the ongoing fee arrangement) does not work in this instance. Exemption from providing an FDS and opt-in renewal notice A provision under s 962CA enables ASIC to exempt a person from the requirement to provide an annual FDS where the person is bound by a code of conduct approved by ASIC. The measure was initially applauded by the industry as a pathway to self-regulation whereby members of professional associations subject to an ASIC-approved Code of Conduct enjoyed some flexibility and professional discretion with regards to the renewal notice requirements. In March 2013, ASIC issued RG 183 Approval of financial services sector codes of conduct. The Financial Planning Association (FPA), the Association of Financial Advisers (AFA) and the SMSF Association (SMSFA — formerly the SMSF Professionals’ Association of Australia (SPAA)) worked with ASIC to agree a code of conduct with ASIC and exempt their members from the renewal notice requirements. ASIC approved the FPA Professional Ongoing Fees Code dated 28 September 2016 (the FPA Code),

and exempted CFP and AFP designated members of the FPA who are subscribed to the FPA Code from compliance with the opt-in requirement. Effectively, FPA members who applied and met the eligibility criteria were included on a public register and did not have to comply with the requirement in s 962K to provide a biennial “opt-in” renewal notice to their clients on an ongoing fee arrangement. The measure was however not really taken up by members. Far from exempting members from the renewal notice requirements, the measure instead utilised the arrangements under the Code to allow advisers to renew fee arrangements with their clients every three years (instead of two years). It is also noted on the FPA website (fpa.com.au/professionalism/fpa-professional-ongoing-fees-code-2/) that “In implementing the Royal Commission recommendation 2.1 — Annual fee renewals, the Government has drafted legislation which will remove the ability for CFP® professionals and Financial Planner AFP® members to register and use the FPA Professional Ongoing Fees Code from 1 July 2020. Until it is clear in the final legislation whether the Government will keep or remove Section 962CA of the Corporations Act, the FPA will not be taking new applications from members under the Code”. Obtaining a client’s agreement to advice and fees If an adviser is charging a fee for their advice and ongoing services, they must obtain a client’s agreement to these ongoing fees and services. This agreement may be set out in a client engagement letter (or similar) and should cover: • the services to be delivered under the ongoing fee arrangement • ongoing fees expressed as a dollar figure and the payment arrangements • that the client can opt-out of the ongoing fee arrangement at any time, and the terms of the ongoing fee arrangement. Insurance commissions Insurance advice is currently exempt from the ban on commissions and volume-based bonuses. However, the Corporations Amendment (Life Insurance Remuneration Arrangements) Bill 2016 (which did not proceed) was intended to amend the Corporations Act 2001 to: • remove the exemption from the conflicted remuneration ban on benefits paid in relation to certain life risk insurance products • enable the ASIC to permit benefits in relation to life risk insurance products when certain requirements are met, and • ban volume-based payments in life risk products. The insurance industry reacted to the Bill in terms of removing volume-based bonuses in anticipation of the Bill being enacted. Commissions paid to licensees on the sale of life insurance products are still allowed. However, it was recommended in the Royal Commission (Rec 2.5) that the caps which pertain to maximum upfront and ongoing commissions paid on sale of life insurance policies under the Life Insurance Framework (as stipulated in ASIC Corporations (Life Insurance Commissions) Instrument 2017/510 (Life Insurance Commissions Instrument)) that ASIC should consider further reducing the cap on commissions in respect of life risk insurance products. The recommendation noted that unless there is a clear justification for retaining those commissions, the cap should ultimately be reduced to zero.

¶8-170 Duty to ensure proper competencies, experience and training Licensees must ensure their advisers have proper experience and training. Training is ongoing so as to keep advisers up to date. There are three types of training: (1) training in investment principles — preparing and providing suitable personal advice, formulation of

advice and operation of the adviser’s business (2) awareness of the environment — keeping up to date with the economy, financial markets, legislation and regulatory requirements (3) product training — if the licensee is the product issuer, the licensee will carry out this training. If not, the adviser’s licensee will still have to arrange for this training. Often it will be provided by the issuer. Authorised representatives, agents and employees must meet the minimum education and training standards set out by ASIC in RG 146 (¶8-260). Note also that for an advice provider to rely on the safe harbour provisions for complying with the best interests duty, they must assess whether they have the expertise to provide advice on the subject matter of the advice sought by the client. If, as a result of making this assessment, they determine that they do not have this expertise, they must not provide advice on that subject matter: s 961B(2)(d). This concurs with the FASEA Code requirement under Standard 10 which says: “you must develop, maintain and apply a high level of relevant knowledge and skills”. It is not appropriate for an adviser to provide advice to a client in an area they do not have appropriate skills, qualifications or accreditation. Many licensees impose policy with regard to specialist advice areas such as gearing and margin lending, aged care, direct equities and self-managed superannuation funds. The continuing professional development (CPD) requirements are part of the education and training standards as described in s 921B(5) of the Act and the Corporations (Relevant Providers Continuing Professional Development) Standard Determination 2018. It will be important for licensees to assess the competence levels of their advisers in providing advice and may restrict their authorisations accordingly.

¶8-180 Duty to provide adequate supervision The adviser must be adequately supervised by the licensee. Supervision needs to be sufficient to ensure that the adviser’s operations are carried on “efficiently, honestly and fairly” (¶8-140). Supervision can take various forms and often, more than one type is used. It includes: • visits by regional managers • periodic site audits by line managers and compliance teams • pre-vetting or paraplanning regarding advice • desk audits of individual client files • develop key risk indicators desk audits • themed audits that examine particular elements including fee-for-no-service, client identification as part of a licensee’s AML-CTF program and digital asset review looking at correct disclosures. ASIC has undertaken surveillance on a number of licensees and has identified that supervision of advisers has not been adequate and these licensees have accepted an Enforceable Undertaking from ASIC, requiring them to upgrade and strengthen the supervision of advisers. It is important that licensees ensure that they review, update and document as necessary their supervision regime regularly.

Tip

As supervision is mandatory, the adviser should accept that it: – is a positive contribution to their business – is a company/industry objective to be compliant – reinforces the culture of compliance.

¶8-190 Duty to adhere to professional codes and standards The adviser needs to be professional at all times and dedicated to providing the highest standard of objective advice within their power. Industry bodies such as the Joint Accounting Bodies (CPA Australia, Chartered Accountants Australia and New Zealand (CAANZ) and the Institute of Public Accountants (IPA)), the Financial Planning Association (FPA), the Association of Financial Advisers (AFA), the Tax Practitioners Board (TPB), the Self Managed Superannuation Funds Association (SMSFA) and the Association of Superannuation Funds of Australia (ASFA) and the Insurance Council of Australia have demonstrated the importance of these aims by implementing Codes of Conduct and disciplinary arrangements.

REGULATION OF FINANCIAL SERVICES ¶8-220 What is a financial product?

Note The definition of a financial product is central to an understanding of what financial services are (¶8230). When an adviser provides financial services in relation to financial products, Ch 7 of the Corporations Act applies.

A financial product is a “facility” through which a person does any of the following: • makes a financial investment — an investor gives money to another person and that other person uses it to generate a financial return or other benefit for the investor • manages a financial risk — avoids or limits the financial consequences of particular circumstances happening, or • makes a non-cash payment or payment by cheque, electronic payment system, travellers cheques or credit or debit card. The range of financial products covered by Ch 7 of the Corporations Act is wide, including: • superannuation • banking • general and life insurance • managed funds • securities

• margin lending • derivatives • smart cards • non-cash payment facilities. SMSF Limited Recourse Borrowing Arrangements Generally, superannuation funds are not permitted to borrow funds except in limited circumstances. Limited recourse borrowing arrangements (LRBAs), such as instalment warrants, are one of the exceptions permitted under the SIS Act, under s 67A. See ¶5-360. The government introduced proposed regulations that would make these LRBAs financial products under the Corporations Act 2001 when entered into by regulated superannuation funds. The proposed regulations provided that: • these LRBAs are financial products under the Corporations Act when acquired by superannuation funds • these LRBAs are not a credit facility under the Corporations Act when acquired by superannuation funds, and • an authorisation to advise and deal in securities or derivatives is held under an AFSL. Implications for AFS licensees and advisers While the proposed regulations did not proceed, it is clear that ASIC considers the recommendation of a LRBA to purchase an investment property by an SMSF as a financial product and expects advisers to be appropriately licensed. Real estate agents and others recommending properties to SMSF’s should consider their position regarding financial services licensing carefully and take legal advice in this regard. Whether the advice is to establish an SMSF or recommend that an SMSF purchase an investment property, it is necessary to be appropriately licensed. In particular, real estate agents who are recommending that an SMSF purchase an investment property are required to hold an AFSL or be a representative of an AFSL. Financial adviser banned for failing to act in clients’ best interests in providing SMSF advice ASIC has banned a financial adviser from providing financial services for three years. ASIC found that the adviser advised clients to establish an SMSF to purchase properties using a LRBA without considering if this was in their best interests. ASIC found that the adviser failed to: • properly identify what it was that his clients wanted advice on, and to reasonably investigate what financial products would best suit their needs • make reasonable enquiries into the clients’ relevant objectives, financial situation and needs • give priority to his clients’ interests, and • understand what was required of him to comply with the best interests duty. ASIC’s MoneySmart website (www.moneysmart.gov.au) has useful information on SMSFs and property. What is not a financial product? It is also important to understand what is not considered to be a financial product. There is a comprehensive list in the Corporations Act s 765A which includes: • excluded or unregistered managed investment schemes, ie schemes where there are less than 20

investors and which are not promoted by a person who is in the business of promoting managed investment schemes • health insurance • insurance provided by the Commonwealth, states or territories including where they are joint insurers • credit facilities • reinsurance • a facility for the transmission and reconciliation of non-cash payments • a financial market, a clearing and settlement facility and a payment system operated as part of a clearing and settlement facility • a foreign currency exchange contract that is settled immediately, and • the purchase of bullion or an investment property, which is specifically excluded from being a financial product (Corporations Act s 763B). However, note that the recommendation to an SMSF trustee to purchase an investment property is considered by ASIC to be a financial product recommendation because superannuation itself is a regulated financial product.

¶8-230 When is a financial service provided? It is important to understand when an adviser is providing a financial service. An adviser is providing a financial service when: • providing financial product advice • dealing in a financial product • making a market for a financial product • operating a registered scheme, or • providing a custodial or depository service. Each of these activities is discussed below. What is financial product advice? An adviser will be providing financial product advice when a: • recommendation • statement of opinion, or • report of a recommendation or statement of opinion, is provided with the intention to influence a person in making a decision in relation to a particular financial product or a group of financial products, or in the circumstances where some might reasonably expect the adviser had that intention. General vs personal advice Advisers must understand when they are actually giving financial product advice and whether that advice is general or personal. This will determine the types of disclosure that must be given (¶8-290) and the level of training that advisers are required to undertake (¶8-260). The following table highlights the difference between the two types of advice.

Personal advice

General advice

The adviser has considered one or more of the objectives, financial situation and needs of the person

The adviser did not consider any of the objectives, financial situation or needs of the person

A reasonable person might have expected the adviser to have considered any of those matters

A reasonable person did not expect the adviser to have considered any of those matters All other financial product advice other than that covered under personal advice

Warning about general advice Where general advice is given to a retail client, the providing entity (through the adviser) must warn the client that: • the advice has been prepared without taking into account the client’s objectives, financial situation or needs • the client should therefore consider the appropriateness of the advice in light of their own objectives, financial situation or needs before acting, and • if the advice relates to the acquisition of a particular financial product, the client should obtain and consider the PDS for that product before making a decision. Where general advice is given, such as at a seminar, clients must be warned that the advice does not take the client’s circumstances into account. The warning must be given at the same time as the advice and must be communicated by the same means. The following warnings would all be sufficient under the class order [CO 05/1195]: • “This advice is general, it may not be right for you” • “This advice is not tailored, so you can’t assume it will be suitable for you” • “This advice may not be suitable for you because it is general advice” • “You will need to decide whether this advice meets your need because I have not considered this.” Under the class order, the general advice warning needs to be given once in any telephone conversation or face-to-face meeting where general advice is provided to a retail client. ASIC in RG 175.52 has also indicated: “The Corporations Act does not require providing entities to use the exact wording in s949A(2) when giving general advice. What is required is that retail clients are warned about the things highlighted in RG 175.51 and that the warning is given to clients at the same time and by the same means as the advice is provided: s949A(3).” RG 175 and personal advice RG 175.40 identifies factors which point to or indicate whether personal advice is being provided. It is worth familiarising yourself with these factors, which include whether: • the adviser offered to provide personal advice (eg in the Financial Services Guide (FSG) or any other material that was given to the client before the advice was provided) • the adviser had an existing relationship with the client where personal advice had previously been provided regularly • the client requested personal advice • the adviser requested information about the client’s personal circumstances

• the advice was directed towards a specific client • the advice contained a general advice warning • the advice appeared to be tailored to the client’s personal circumstances and whether it makes reference to those circumstances, and • the adviser received or already possessed information about the client’s relevant personal circumstances.

Tip Remember that this is an objective test, for example, the question is whether a reasonable person might expect the adviser to have considered the information in providing the advice. Therefore, as a matter of best practice, if it is reasonable for the client’s objectives, financial situation or needs to be considered, then on an objective basis, it is personal advice, regardless of whether the adviser believed that it was just general advice. Remember also that the adviser need not consider all the client’s relevant circumstances (eg the client’s objectives, financial situation or needs) for the advice to be personal. If at least one of these is considered, then it is personal advice and the obligations and standards in relation to providing personal advice have to be met. It cannot be identified as general advice.

ASIC in RG 175.46 states that advice may be personal advice even when: • it is not given face-to-face • there is no direct contact with the client • it only relates to one product • it is given in a seminar • the client is a body corporate, or • the adviser did not (subjectively) intend to provide personal advice. The FPA has provided examples of how to make recommendations to clients. The Statement of Advice Guide example recommends that if an adviser is giving general advice to a retail client, the client should be given the following warning. This should be done at the same time as when the advice is given, and in the same way. If an adviser uses the SoA to give personal advice to their client, they may include the warning in the SoA. Example This advice has been prepared without taking account of your objectives, financial situation or needs. You must therefore assess whether it is appropriate, in the light of your own individual objectives, financial situation or needs, to act upon this advice. If this advice contains information about a particular financial product, you should ensure you obtain a Product Disclosure Statement in respect of that product prior to making any decision to acquire that product. It may be necessary to carefully tailor the warning, having regard to the completeness of the information which the adviser has on the product and whether or not a PDS or some alternative form of disclosure document is available.

Caution

Merely calling advice “general advice” does not make it general advice. An adviser may cross over into providing personal advice even though the adviser may believe that he or she is providing general advice or in fact is not providing any advice at all (eg in a preliminary discussion).

Exemptions There are some exemptions from providing financial product advice, which means the Corporations Act does not apply, including situations where: • an adviser is providing advice that does not relate to a financial product • a registered tax agent provides advice in the ordinary course of business • a lawyer provides advice about the matters of law, legal interpretation or the application of the law • an accountant advises in relation to the preparation or auditing of financial statements (¶8-250) • information or estimate of the cost of a financial product is provided where that cost or estimate is based on the suggested value of an item • a clerk or cashier performs administrative and support functions to an adviser, which does not involve judgment about a financial product, or • the media publishes general financial product advice. Further exemptions can be found in the Corporations Regulations 2001, reg 7.1.29 to 7.1.33F. Giving information, general advice and scaled advice Regulatory Guide RG 244 explains the differences between giving factual information, general advice and personal advice. Factual information Factual information is objectively ascertainable information, the truth or accuracy of which cannot reasonably be questioned: Good quality factual information can often be useful for clients wishing to better understand the financial products or strategies available to them. An adviser does not need to hold an AFSL to give factual information to clients. General advice An adviser can provide general advice to a client even if the adviser has personal information about the client. General advice is not personal advice if an adviser clarifies with the client when giving the advice that the adviser is not giving personal advice, and the adviser has not in fact considered the client’s relevant circumstances (ie their objectives, financial situation or needs). It is permissible to give general advice using personal information about a client’s relevant circumstances to choose general advice that is relevant and useful to them. Scaled advice ASIC’s view on scaled advice is set out in RG 175 and RG 244. An adviser: • must identify the subject matter of the advice that has been sought by the client (whether explicitly or implicitly) • or the client can suggest limiting the subject matter of the advice (s 961B(2)(b)(i)) • when providing scaled advice, should follow the seven advice steps as detailed in RG 175.236–RG 175.241 in order to meet their best interests duty

• must make enquiries tailored to the advice sought, based on the subject matter of the advice and the client’s relevant circumstances (note s 961B) • should not reduce the scope of advice to exclude critical issues that are relevant to the subject matter of the advice (note s 961B(2)(g)) • must not adjust the scope of the advice to suit the topics or subject matter that the adviser gives advice on (RG 244.68 D5) • must clearly explain to the client the limited scope of the advice being given (RG 244). Conduct not financial product advice Persons that do not provide financial product advice are not required to meet the training standards. Examples of conduct that are not treated as financial product advice include: • conduct done in the course of work of a kind ordinarily done by clerks or cashiers (s 766A(3)) • conduct being the provision of an exempt document or statement (s 766B(1A)), and • certain general advice given by a financial product issuer (reg 7.1.33H). Dealing in a financial product Advisers are dealing in a financial product when they are: • applying for or acquiring a financial product • issuing or dealing with a financial product • underwriting securities or managed investment interests • varying a financial product • disposing of a financial product, or • arranging for a person to engage in any of these conducts. Making a market for a financial product An adviser is providing a financial service when they make a market for a financial product. This refers to: • regularly stating a price at which an adviser proposes to acquire or dispose of financial products on their behalf • when others have a reasonable expectation that they can regularly affect transactions at the stated prices, or • actions that do not comprise the operation of a financial market.

Tip This financial service relates mainly to markets in securities and derivatives.

Operating a registered scheme Operating a managed investment scheme that is registered under the Corporations Act represents a financial service. This refers to:

• giving advice in relation to interests in the scheme • deals in interests in the scheme, and • making a market for interests in the scheme. Providing a custodial or depository service An adviser will generally provide a custodial or depository service to a client if there is an arrangement with the client (or someone else with whom the client has an arrangement) to hold a financial product or a beneficial interest in a financial product on behalf of the client.

Checklist Once it has been determined that a financial service has been provided, an adviser needs to establish: ☑ whether the service is provided to a retail or wholesale client (¶8-240) ☑ whether a licence or some other authorisation is required (¶8-250), and ☑ what disclosure obligations must be met (¶8-290).

¶8-240 Retail or wholesale client? Advisers are faced with significantly more detailed disclosure and conduct requirements when providing financial services to retail clients than to wholesale clients. This is due to the assumption that wholesale clients have a greater understanding and ability to rely upon their own resources compared to retail clients. FOFA Regulations, effective from 1 July 2015, have been made which applies the current retail and wholesale client tests to other parts of the Corporations Act 2001. The following are therefore wholesale clients: • a person that meets the net assets test, or the income test (both specified in the principal regulations) is not treated as a retail client where they acquire a product or service for a company or trust that they control • the net assets and gross income of a company, or trust that a person controls, can be included in determining the persons net assets or income for the purpose of qualifying as a wholesale client • where a financial product or service is acquired by a body corporate as a wholesale client, related bodies corporate of the client are also considered to be wholesale clients • a person is considered to be a professional investor if the person has, or is in control of, gross assets of at least $10m, including any assets held by an associate or under a trust that the person manages. The net assets test or income test A client that has net assets of at least $2.5m or has had a gross income for each of the last two financial years of at least $250,000 (a certificate provided by a qualified accountant within the preceding six months confirming this is required). Superannuation business Superannuation funds with assets of less than $10m are classified as retail clients. Superannuation funds with assets of more than $10m are classified as wholesale clients.

All retirement savings account providers are wholesale clients.

Tip An adviser who provides advice to an employer about default funds (the fund where the employer makes contributions for the benefit of employees that have not chosen a fund) is providing a financial service to a retail client.

Advisers are faced with significantly more detailed disclosure and conduct requirements when providing financial services to retail clients than to wholesale clients and with the increased complexity of providing retail client advice under the FASEA Code, many advisers and licensees have looked at wholesale advice as potentially “easier” to provide. The following requirements apply when providing financial services to retail clients: • licence (¶8-250) • FSG (¶8-300) • SoA (¶8-310) • PDS (¶8-320) • anti-hawking (¶8-425) • compensation • complaints/dispute resolution (¶8-610) • cooling-off period (¶8-320) • training obligations (¶8-260). Obtaining a licence and providing training are the only requirements from this list that apply when offering a financial service to wholesale clients. While these requirements specified in the Corporations Act do not apply to providing advice to a wholesale client, an adviser is still required to have a reasonable basis for their advice and have a fiduciary duty to their clients (¶8-120). It is important to note that wholesale clients do not enjoy the same protections as retail clients (they do not have access to AFCA) but are generally wealthier and perhaps better able to pursue legal options in the event of a claim. For this reason, many licensees do not include it as part of their offering and professional indemnity (PI) insurers do not provide cover for it. There is also some confusion as to whether wholesale advice is caught by FASEA. There is acknowledgement that there is a genuine need for sophisticated investors to have access to an advice process which supports a legitimately scoped engagement. It is best practice that where a client presents to an adviser with an accountant’s letter stating that the client meets the abovementioned financial thresholds, that the adviser attests that they are reasonably satisfied that the client has the financial capability and knowledge to be considered sophisticated, which can be recorded in file notes to show what conversation the adviser had with that client to determine their level of sophistication. Wholesale client advice is not simply about investing the client with no disclosure documentation. In an environment where all clients are treated as retail clients, licensees generally require that the adviser provides an advice document to clients qualifying as wholesale investors with inclusions such as: • the consequences of the advice

• the basis of the advice • the costs to the clients (product and advice fees and costs) involved with implementing the advice • disclosure of remuneration including associated entities and conflicts of interest • any referral payments made • verification of the clients meeting the definition of “Wholesale Clients”, or, if a SMSF trustee, that they meet the “Professional Investor” test • analysis and disclosure of the risks to the client, and, based on the above • file noting and attestation from the adviser detailing the conversations conducted with the client and showing why the adviser is reasonably satisfied that the client has the financial capability and knowledge to be consider sophisticated. The best interest obligation with regards to wholesale advice Note that while the best interest duty in s 961B of the Corporations Act 2001 applies to advice provided to retail clients only, advisers are bound by the best interest duty in the FASEA Code. There is a general duty even in the case of wholesale/sophisticated investors to ensure that the investment that is offered to them is suitable for that investor given their level of sophistication (Wingecarribee Shire Council v Lehman Brothers Australia Ltd (in Liq) [2012] FCA 1028 (Lehman Brothers Case) and Bathurst Regional Council v Local Government Financial Services Pty Ltd (No 5) [2012] FCA 1200 (LGFS Case)). The decision in the Lehman Brothers Case indicated that advisers have a fiduciary duty to ensure that the recommended financial product is an appropriate investment for the particular client concerned. This means evidencing that (similar to the FASEA requirement) the adviser can show they are reasonably satisfied that the client understands the features, fees, costs, benefits and risks of the recommended product.

¶8-250 Uniform licensing regime The Corporations Act imposes a uniform licensing regime. Three types of licences exist: (1) the AFSL (2) the Australian financial market licence, and (3) the Australian clearing and settlement facility licence. This chapter examines the requirements that only apply to an AFSL, as it is the most common of the three types. What is an AFSL? It is a licence that covers those who carry on a business of providing financial services. It replaces many of the types of licences or registrations previously required, such as a dealer’s licence and insurance broker’s registration. Carrying on a business refers to activities that are: • systematic • continuous, and • repetitive. Who needs an AFSL? An AFSL is required by any person generally involved in:

• the issuing or dealing of financial products, apart from the excluded items like credit or health insurance, or • advising. Who is exempt from holding an AFSL? A number of people are exempt from holding an AFSL, including authorised representatives or advisers of a licensee who are authorised to provide the financial service. The term “representative” includes “advisers” and extends to: • authorised representatives • directors and employees of the licensee • the licensee’s related bodies corporate, and • any other person acting on the licensee’s behalf. Accountants Accountants who, until 30 June 2016, provided advice to their clients on the decision to acquire or dispose of an interest in an SMSF were exempt from holding an AFSL in relation to that advice. The exemption did not cover the provision of advice about the particular investments that an SMSF may hold, and such advice remained subject to the licensing rules. The exemption applied during the transition period and was limited to recognised accountants who held appropriate qualifications to provide the advice. Recognised accountants were members of: • CPA Australia, who are entitled to use the post-nominals “CPA” or “FCPA” • the Institute of Chartered Accountants in Australia, who are entitled to use the post-nominals “CA”, “ACA” or “FCA”, or • the Institute of Public Accountants, who are entitled to use the post-nominals, “MIPA” or “FIPA”, and are subject to and comply with the relevant bodies’ continuing professional education requirements. Accountants limited AFSL Up until 30 June 2016, accountants were permitted to provide advice on the establishment and closing of SMSFs without holding an AFSL. This exemption was removed from 30 June 2016. A limited AFSL was created to enable accountants to give certain types of advice. ASIC guidance on limited AFSLs ASIC has released online guidance and information sheets to help limited AFS licensees and their representatives understand their key obligations. Information Sheet 227 “What can limited AFS licensees do?” explains all the activities that limited AFSLs can be authorised to carry out. A limited AFS licensee can provide the following limited financial services: • financial product advice about: – SMSFs – a client’s existing superannuation holdings, to the extent required for making a recommendation to establish an SMSF or providing advice to a client on contributions or pensions under a superannuation product • “class of product advice” about:

– superannuation products – securities – simple managed investment schemes – general insurance products – life risk insurance products – basic deposit products • arranging to deal in an interest in an SMSF. Class of product advice is financial advice that does not make a recommendation about a specific financial product. Information Sheet 228 “Limited AFS licensees: Advice conduct and disclosure obligations” covers: • preparing and providing a Financial Services Guide (FSG) • best interests duty and related obligations • complying with the best interests duty when providing advice about self-managed superannuation funds (SMSFs) • preparing and providing a Statement of Advice (SoA) • record-keeping obligations that apply to personal advice • general advice warning • conflicted remuneration • ongoing fee arrangements and Information Sheet 229 “Limited AFS licensees: Complying with your licensing obligations” (INFO 229) covers: • general licensing obligations • stay within scope of your limited AFS licence authorisations • training, education and ethics • financial advisers register • dispute resolution • compensation and insurance arrangements • breach reporting • financial requirements • ongoing financial reporting • advertising financial services

One-page Quick Guide ASIC has also published a one-page quick guide: Key obligations when giving advice under a limited AFS licence. The limited licensing regime was intended to be a popular option for accountants working with SMSF trustees but has not proven to be so, particularly with the introduction of FASEA. Conduct exempt from licensing Persons who provide financial product advice for which there is an exemption under the Corporations Act from the obligation to hold an AFSL are not required to meet the training standards. Examples of financial product advice that are exempt from the licensing regime include: • the provision of general advice in the media by product issuers (or by persons acting on behalf of product issuers) where the advice relates to the issuer’s own products and where certain warnings are provided (reg 7.6.01(1)(o)), and • referrals that are exempt from licensing under reg 7.6.01(1)(e) or (ea). Paraplanners ASIC recognises the unique position of paraplanners in relation to their training. RG 146 Licensing: Training for financial product advisers, RG 146.27 states that ASIC will not require paraplanners to meet the training standards set out at RG 146 provided a person who does meet the standard plays a material role in, and remains responsible for (together with the licensee) the provision of financial product advice to retail clients. This means that paraplanners who do not meet RG 146 obligations require additional compliance considerations by a licensee. RG 146.27–RG 146.29 sets out the ASIC compliance licensing requirements when using a paraplanner that does not meet RG 146 requirements and the licensee’s obligations. In summary: • the licensee is ultimately responsible for the provision of financial services under the licence. Therefore, the licensee is responsible for the provision of advice and conduct by the paraplanner. This holds true, regardless of whether the paraplanner is RG 146 compliant or not. • to meet those obligations, the licensee must: – have in place procedures to ensure that an RG 146 qualified representative reviews any draft SoA prepared by a paraplanner – ensure that the RG 146 qualified representative assesses the SoA to determine whether all legal obligations have been complied with and take any necessary action to ensure such compliance – manage and lead any verbal explanation by paraplanners and trainee advisers of the financial product advice to the client, and – ensure that, while paraplanners and trainee advisers do not have to comply with the training standards, paraplanners and trainee advisers have the necessary competence to perform their roles.

Caution The more involved a person is with the client in the financial planning process, the more likely the person will need to be licensed or authorised. There can be a fine line between assisting in the explanation of financial product advice to retail clients and actually giving the advice. Remember, under consumer protection law, when there is doubt that doubt is likely to go against the licensee. RG 146.27 also requires that there are effective means of monitoring what paraplanners provide to retail clients, and that licensees must ensure that their paraplanners have the necessary competencies to perform their functions.

Therefore, it is important the licensee has a documented compliance procedure on the supervision, monitoring and training of paraplanners. If the paraplanner is an employee, the nature of their services should be fully documented in a position description. If the service is outsourced, the services of the paraplanner should be clearly documented in a service level agreement. It is important to note that the licensee remains equally liable for the activities of an outsourced paraplanning service pursuant to the Corporations Act s 769B.

Tip When assessing whether a communication will constitute financial product advice, the overall context, including its presentation and the circumstances of the parties, are relevant factors.

¶8-260 Training of financial product advisers For existing advisers at 1 January 2019 and to whom the FASEA requirements apply, RG 146 provides guidance to ensure anyone who gives financial product advice directly to retail clients: • has undertaken education and training to improve their knowledge, skills and integrity, and • undergoes continuing education. What are the RG 146 requirements? The Corporations Act sets out minimum training requirements. RG 146 sets out ASIC’s expectations for the minimum education and training standards which ASIC requires of a licensee or representative of a licensee who provides financial services to retail clients. All advisers are required to meet the generic knowledge requirements, including: • the economic environment • operation of financial markets, and • financial products. In addition, advisers must meet the specialist knowledge and skill requirements relevant to all the areas and products they advise on. The specified specialist knowledge areas are: • financial planning • securities • derivatives (including superannuation instalment warrants) • managed investments • superannuation • SMSFs • insurance • deposit products and non-cash payment facilities, and • margin lending. Generally, advisers need to demonstrate that they are able to:

• establish a relationship with the client • identify a client’s objectives, needs, financial situation and risk profile • develop appropriate strategies and solutions • present appropriate strategies and solutions to the client • coordinate the implementation of the agreed plan/policy/transaction • complete and maintain necessary documentation, and • provide ongoing service at the client’s option. Advisers who provide only general advice will still need to have both generic knowledge and specialist knowledge relevant to their activities and the financial products they advise upon, but they need not meet the skill requirements. However, they must still be competent to provide general advice.

Note Advisers also need to ensure that under their AFSL: • their services are provided efficiently, honestly and fairly (¶8-140) • their services comply with the financial services law • they maintain the required competencies (¶8-180), and • they undergo adequate training.

Currently, there are two tiers of training that apply depending on the complexity of the activities that licensees and their representatives are involved in. The activities and general requirements for each of the tiers are shown below: Tier 1

Tier 2

Activity

Generally, all advisers are required to meet Tier 1 unless they are advising in the activities under Tier 2

– General insurance products, except personal sickness and accident – Basic deposit products – Non-cash payment facilities

Requirements

“Diploma” level under the Australian Quality Training Framework

“Certificate III” level under the Australian Quality Training Framework

¶8-265 The introduction of FASEA, the exam and the Code of Ethics Background to lifting the professional, ethical and education standards in the financial services industry In recent years, there has been a steady push to raise the professional, ethical and educational standards of financial advisers. In December 2014, the Parliamentary Joint Committee (PJC) on Corporations and Financial Services’ inquiry into proposals to lift the professional, ethical and education standards in the financial services industry presented its recommendations to government. The PJC report outlined a comprehensive model to increase the professional standards of advisers,

involving a co-regulatory approach where government, professional associations, industry and academia all work in partnership. Corporations Amendment (Professional Standards of Financial Advisers) Act 2017 Under the Corporations Amendment (Professional Standards of Financial Advisers) Act 2017: • new financial advisers (from 1 January 2019) are required to have a degree, to undertake a professional year and pass an exam. • a new standards body, the FASEA would develop and set education standards, professional year requirements, CPD requirements and develop a comprehensive code of ethics for financial advisers. FASEA would also have the ability to exempt “highly experienced advisers with exceptional skills and qualifications” from sitting the new industry exam in due recognition of their standing in the industry. The exam The exam is a required component of the education standard that all advisers are required to pass to provide personal financial advice to retail clients. Existing advisers were required to pass the exam before 1 January 2021. However, after much lobbying from the professional associations, and potentially in response to the COVID-19 pandemic, legislation was passed to allow advisers an additional year to complete the exam (by 1 January 2022). From 1 January 2019, new entrants to the industry are required to pass the exam after they have completed a FASEA approved degree, and before commencing Quarter 3 in their professional year. The exam tests the practical application of advisers’ knowledge in the following competency areas: • Financial Advice Regulatory and Legal requirements (including Corporations Act ch 7, AML, Privacy and Tax Agents Services Act (TASA) 2009) • Financial Advice Construction — suitability of advice aligned to different consumer groups, incorporating consumer behaviour and decision making • Applied ethical and professional reasoning and communication — incorporating FASEA Code of Ethics and Code Monitoring Bodies (now Disciplinary Body). FASEA provides practice questions and other exam preparation guidance on its website. Candidates are required to pass to a credit level and are notified of a pass or a fail only. For those advisers who do not pass, there is no limit on the number of re-sits available noting that advisers cannot re-sit the exam within three months of their last attempt. The consequences of not passing the exam by the 1 January 2022 deadline are that the adviser is: • shown as non-compliant on FAR • unable to give personal advice to retail clients • becomes a new entrant (with the education requirements and the need to do a Professional Year). Further education requirements from 1 January 2019 The Corporations Amendment (Professional Standards of Financial Advisers) Act 2017 introduced various requirements relating to the professional standards of advisers. “Existing providers” transitional arrangements Advisers who were listed on the public register of financial advisers (see below) between 1 January 2016 and 1 January 2019 continue to be recognised as an “existing provider” under the new professional standards. If a person is an “existing provider”, they have time until 1 January 2022 to pass the exam and until 1 January 2026 to complete an approved qualification. In the meantime, they can continue to work as a

financial adviser. Financial advisers can demonstrate that they are an “existing provider” if they were: • “current” on the Financial Advisers Register (FAR) at any time between 1 January 2016 and 1 January 2019, and • not banned, suspended or disqualified as of 1 January 2019. ”New entrants”, that is, those advisers who do not meet the criteria shown above to be considered “existing providers” must pass an exam, complete an approved qualification to work as a financial adviser and must also undertake a year of work and training (Professional Year). For new entrants from 1 January 2019 The requirement is that they: • hold an Australian Qualifications Framework (AQF) Bachelor degree (AQF7) made up of 24 courses, of which up to 12 courses will be core, covering fields that include: – ethics, professional attitudes and behaviours – financial planning and advice process – technical requirements, or • hold an approved graduate diploma (AQF8), or an approved masters degree (AQF9) which included the embedded bridging knowledge areas. FASEA adopted the Financial Planning Education Council (FPEC) framework for approval of courses and programs at the level of AQF7 Bachelor degree. For existing advisers By 1 January 2026, existing advisers are required to have completed a FASEA approved bachelor degree (AQF7) level or above or hold an equivalent qualification. FASEA has published an Approved Degree list which includes current and historical approved degrees and courses. The list is updated periodically as additional courses are approved by FASEA. FASEA has established four pathways for existing advisers to meet the education requirements (FPS001 Education Pathways Policy): 1. Approved Degree Pathway 2. Relevant Degree Pathway 3. Non-Relevant Degree Pathway 4. No Degree Pathway Education Further education required by no pathwaysrequirements later than 1 January 2026 Approved degree

FASEA approved Bachelor Degree (AQF7) or Graduate Diploma (AQF8) or Masters Degree (AQF9)

Bridging course* 1 subject: FASEA Code of Ethics

Relevant degree

8 subjects at AQF7, 8 or 9 in one or more of the designated fields of study in any combination — financial planning, investment, accounting, taxation law (as defined

Bridging course* 4 subjects at AQF8: • Financial Advice Regulatory and Legal Obligations bridging course • Ethics for Professional Advisers

Non-relevant degree

No degree

by the TPB), finance law, finance, business law (as defined by the TPB), estate law, banking, economics

bridging course • Behavioural Finance: Client and Consumer Behaviour, Engagement and Decision Making, and • FASEA approved unit (Financial Advice Capstone subject).

4 to 7 subjects at AQF7, 8 or 9 courses in one or more of the designated fields of study in any combination — financial planning, investment, accounting, taxation law (as defined by the TPB), finance law, finance, business law (as defined by the TPB), estate law, banking, economics

Approved graduate diploma 7 subjects at AQF8: • Financial Advice Regulatory and Legal Obligations bridging course • Ethics for Professional Advisers bridging course • Behavioural Finance: Client and Consumer Behaviour, Engagement and Decision Making bridging course, and • 4 FASEA approved units — to be selected by the existing adviser from a FASEA approved Graduate Diploma Approved graduate diploma 8 subjects at AQF8: • Financial Advice Regulatory and Legal Obligations bridging course • Ethics for Professional Advisers bridging course • Behavioural Finance: Client and Consumer Behaviour, Engagement and Decision Making bridging course • 5 FASEA approved units — to be selected by the existing adviser from a FASEA approved Graduate Diploma or Other approved qualifications Bachelors degree (AQF7), or Masters degree (AQF9)

*Bridging courses: FASEA has determined bridging courses that are a legitimate part of the education standard for compliance with s 1546B(1)(b). They are: 1. Financial Advice Regulatory and Legal Obligations (Corporations Act, Anti-Money Laundering, Privacy and Tax Practitioners Board) 2. Ethics for Professional Advisers (including the FASEA Code of Ethics and Code Monitoring Bodies) 3. Behavioural Finance: Client and Consumer Behaviour, Engagement and Decision Making Depending on the pathway for the new entrant or existing adviser, advisers are required to undertake one or all of the abovenamed courses. The courses are at an AQF8 standard and offered standalone during the transition period (FPS002 — Program and Provider Accreditation Policy). Recognition of prior learning (RPL) and professional designations FASEA has also approved a list of options to provide either one or two credit exemptions from the above requirements (subject to a one course minimum for all pathways being the FASEA Code of Ethics course) where advisers have attained relevant designations/accreditations from their practicing body/professional association. Various industry designations are listed in FSP001 for members of the Association of Financial Advisers

(AFA), Financial Planning Association (FPA), CPA Australia, Chartered Accountants Australia and New Zealand (CAANZ), CFA Institute (CFA) and Stockbrokers and Financial Advisers Association (SAFAA) among others. All advisers, both new and existing, will be required to undertake CPD and be party to a code of ethics. FASEA continuing professional development standard (all advisers) The FASEA CPD standard commenced on 1 January 2019. All financial advisers are required to participate in development programs and activities that ensure they maintain and extend their professional capabilities, knowledge and skills, including keeping up-to-date with all regulatory, technical and other developments relevant to professional financial advice. Financial advisers are required to complete 40 hours of CPD each year, of which 70% must be approved by their licensee (including a maximum of four hours of professional reading). The minimum hours for CPD across the mandatory categories are: • Technical — five hours • Client Care and Practice — five hours • Regulatory Compliance and Consumer Protection — five hours, and • Professionalism and Ethics — nine hours The balance up to 40 hours must consist of qualifying CPD. Transitional arrangements for 2019 will be on a pro-rata basis for licensees whose CPD year did not commence on 1 January 2019. In order to comply with these obligations, licensees must ensure that they, and all employees who provide financial product advice on their behalf, meet the specified training standards. In response the COVID-19 pandemic and to deal with the fact that many CPD opportunities such as licensee and association professional development days and education conferences have been impacted by work-from-home, social distancing and in particular situations, state-sponsored lockdowns, FASEA announced on 25 June 2020 that it would provide a three month extension to the deadline for advisers to meet the 40-hour CPD requirement. FASEA Code of Ethics FASEA’s Code of Ethics commenced from 1 January 2020. The Code sets out five values of trustworthiness, competence, honesty fairness and diligence and 12 ethical standards covering ethical behaviour, client care, quality process and professional commitment. Ethical behaviour 1. Advisers must act in accordance with all applicable laws, including this Code, and not try to avoid or circumvent their intent 2. Advisers must act with integrity and in the best interests of each of their clients 3. Advisers must not advise, refer or act in any other manner where they have a conflict of interest or duty. Client care 4. Advisers may act for a client only with the client’s free, prior and informed consent. If required in the case of an existing client, the consent should be obtained as soon as practicable after this Code commences. 5. All advice and financial product recommendations that an adviser gives to a client must be in the best interests of the client and appropriate to the client’s individual circumstances. The adviser must be satisfied that the client understands their advice, and the benefits, costs and risks of the financial

products that the adviser recommends, and the adviser must have reasonable grounds to be satisfied. 6. Advisers must take into account the broad effects arising from the client acting on upon the advice given and actively consider the client’s broader, long-term interests and likely circumstances. Quality process 7. The client must give free, prior and informed consent to all benefits an adviser and principal will receive in connection with acting for the client, including any fees for services that may be charged. If required in the case of an existing client, the consent should be obtained as soon as practicable after this Code commences. Except where expressly permitted by the Corporations Act 2001, an adviser may not receive any benefits, in connection with acting for a client, that derive from a third party other than their principal. The adviser must satisfy themselves that any fees and charges that the client must pay to them or their principal, and any benefits that the adviser or their principal receive, in connection with acting for the client are fair and reasonable and represent value for money for the client. 8. Advisers must ensure that records of clients, including former clients, are kept in a form that is complete and accurate. 9. All advice given, and all products recommended, to a client must be offered in good faith and with competence and be neither misleading nor deceptive. Professional commitment 10. Advisers must develop, maintain and apply a high level of relevant knowledge and skills. 11. Advisers must cooperate with ASIC and monitoring bodies in any investigation of a breach or potential breach of this Code. 12. Advisers must uphold and promote the ethical standards of the profession and hold each other accountable for the protection of the public interest. The intent of the standards is to create that professional and ethical overlay to the existing requirements under the Corporations Act and regulations. As noted in the FASEA legislative instrument, “this Code imposes ethical duties that go above the requirements in the law. It is designed to encourage higher standards of behaviour and professionalism in the financial services industry”. Throughout 2020, it is fair to say that the industry has struggled with adequately interpreting and implementing the FASEA standards into the normal FOFA-compliant advice process. An example would be Standard 3 where under the Corporations Act, conflicts of interest may be acceptable if accurately disclosed and managed. However, under Standard 3, the adviser must not act where there is a conflict of interest. Another example might be the scoping of advice outcomes, which have been a feature of FOFA compliant advice to target affordable, single issue advice (so long as the safe harbour provisions are met), whereas under FASEA (particularly Standards 2, 5 and 6), where an adviser can consider the client’s express wishes but are not relieved from the requirement to undertake broader fact finding and assess the client’s holistic needs. Code monitoring and disciplinary body A key legislative obligation was for advisers to be a member of an ASIC-approved compliance scheme by 1 January 2020. From late 2018 and throughout 2019, various bodies had expressed interest in providing code monitoring services to the industry. In December of 2018, six professional associations, Financial Planning Association of Australia (FPA), Association of Financial Advisers (AFA), Boutique Financial Planners (BFP), Financial Services Institute of Australasia (FINSIA), Self Managed Super Fund Association (SMSF Association) and Stockbrokers and Financial Advisers Association (SAFAA) signed an historic agreement to develop a code monitoring body for their members. A special purpose company, Code Monitoring Australia (CMA) Pty Ltd, a wholly owned subsidiary of the FPA, was established for the

purpose of operating the compliance scheme, which was to be called the Financial Advisers Monitoring Scheme (FAMS). By October 2019, the landscape had a changed with the government effectively aborting an industrybacked code-monitoring body in favour of pursuing the establishment of a single disciplinary body as recommended in the Royal Commission Final Report. With time running out for advisers to register with an ASIC-approved compliance scheme, on 28 November 2019, ASIC has released ASIC Corporations (Amendment) Instrument 2019/1145 to provide relief to Australian financial services (AFS) licensees from financial adviser compliance scheme obligations. The legislative instrument provided certainty to AFS licensees that their financial advisers would not be in breach of the law due to their inability to register with an ASIC-approved compliance scheme by 1 January 2020, as initially required. ASIC has granted a three-year exemption to all AFS licensees from the obligation to ensure that their financial advisers are covered by a compliance scheme and from the associated notification obligations. The exemption applies until 31 October 2022. The Disciplinary Body is due to be established from 1 January 2021. In the meantime, ASIC (noting in a media release from 26 November 2019) stated that it “expects licensees to ensure that expects AFS licensees to take the following steps to ensure that their financial advisers comply with the Code include the following systems and processes: • making sure that their advisers are aware that they need to comply with the Code from 1 January 2020 onwards • providing training and/or guidance to their advisers on the types of conduct that is consistent/inconsistent with the Code • facilitating individual advisers’ ability to raise concerns with the AFS licensee about how the licensee’s systems and controls may be hindering their ability to comply with the Code, and acting on those concerns where appropriate • considering whether advisers are complying with the Code as part of their regular, ongoing monitoring of adviser conduct, and • when it is in place, considering the decisions of the new disciplinary body and making any necessary changes to their systems and processes. ASIC will take into account the context in which AFS licensees are operating in determining what constitutes reasonable steps. This includes the current dynamic regulatory environment, the timing of guidance provided by FASEA about the meaning of the Code, and the evolving industry understanding about the meaning and implications of the Code. ASIC may take action where there are breaches of the law by financial advisers or their AFS licensees”. Public register of financial advisers ASIC launched the financial advisers register (FAR) in 2015. The register contains details of persons employed or authorised — directly or indirectly — by Australian Financial Services licensees to provide personal financial advice to retail clients on investments, superannuation and life insurance. It also includes the financial adviser’s qualifications, training and professional membership details. The register includes: • the adviser’s name, registration number, status and experience • the adviser’s qualifications and professional association memberships • the adviser’s licensee, previous licensees/authorised representatives and business name

• what product areas the adviser can provide advice on • any bans, disqualifications or enforceable undertakings, and • details around ownership of the financial services licensee and disclosure of the ultimate parent company where applicable.

¶8-270 Restrictions on use of terminology Words and expressions only to be used if strict tests are met The words “independent”, “impartial” and “unbiased”, and words or expressions of similar meaning, cannot be used unless the following conditions are met: • no adviser or licensee receives commission, volume bonuses, other gifts or benefits from product issuers that may reasonably be expected to influence them • advisers and licensees operate free from direct or indirect restrictions for the financial services provided, and • advisers and licensees operate without any conflicts of interest arising from associations or relationships with product issuers that might reasonably be expected to influence them in providing the services. ASIC cracks down on use of “non-aligned”, “independently owned” and “non-institutionally owned” ASIC has updated Regulatory Guide 175 Licensing: Financial product advisers — conduct and disclosure (RG 175), to include guidance that terms such as “independently owned”, “non-aligned” and “noninstitutionally owned” are restricted under the Corporations Act. Financial services providers can only use these terms if they meet the requirements set out in s 923A of the Act, which prohibits a person from using certain restricted words and expressions in relation to a financial services business or in the provision of a financial service unless: • the person (including anyone providing a financial service on their behalf or anyone on whose behalf they are providing a financial service) does not receive: – commissions (apart from commissions that are rebated in full) – forms of remuneration calculated on the basis of the volume of business placed by the person with an issuer of a financial product, or – other gifts or benefits from product issuers which may reasonably be expected to influence that person • the person operates free from direct or indirect restrictions relating to the financial products in respect of which they provide financial services, and • the person is free from conflicts of interest that might arise from any relationships with product issuers and which might reasonably be expected to influence the person. Section 923A(5)(a) specifies that the words “independent”, “impartial”, and “unbiased”, or any other words “of like import” are restricted words for the purposes of s 923A. RG 175 confirms that terms such as “independently owned”, “non-aligned” and “non-institutionally owned” are “of like import” to the specified words in s 923A(5)(a), and therefore, restricted under s 923A. This means that any adviser who receives unrebated product commissions (including for insurance products) or any remuneration based on volume of business can no longer describe themselves to consumers as non-aligned or independently owned, regardless of ownership structures.

ASIC has also stated that in some cases, being subject to a non-open approved product list (APL) would mean being unable to use any of the relevant terms, but has said accepting asset-based fees should not be considered a breach of s 923A. Other restricted terms The following terms are restricted and their assumption and use is not permitted unless licence conditions permit it: • “stockbroker” or “sharebroker” — these words may be used if the licence permits the person to provide a financial service relating to securities, whether or not other financial services may also be provided under the licence, and the person is a participant in a licensed securities market • “futures broker” — this expression may be used if the licence permits the person to provide a financial service relating to derivatives, and the person is a participant in a licensed market that deals in derivatives • “insurance broker” or “insurance broking” — these expressions may be used if the licence permits the person to provide a financial service relating to contracts of insurance and, in providing that service, the person acts for clients who intend to be insured • “general insurance broker” — this expression may be used if the licence permits the person to provide a financial service relating to contracts of general insurance and, in providing that service, the person acts for clients who intend to be insured • “life insurance broker” — this expression may be used if the licence permits the person to provide a financial service relating to contracts of life insurance and, in providing that service, the person acts for clients who intend to be insured, or • any other word or expression prescribed by the Regulations. Financial planner or financial adviser The update to RG 175 also reflects the introduction of s 923C into the Corporations Act by the Corporations Amendment (Professional Standards of Financial Advisers) Act 2017, to restrict the use of the titles “financial adviser” and “financial planner”. This restriction commences on 1 January 2019 for new advisers, while existing advisers have until at least 1 January 2022 to satisfy the first of their training requirements.

¶8-280 General obligations of licensees General obligations of the Corporations Act require licensees to have a strong compliance system and procedures in place in the conduct of its business. Ultimately this will affect advisers. Most of these obligations are met when licensees and their advisers adopt best practice principles (¶8-100).

Checklist The general obligations of licensees are to: ☑ ensure the financial services are provided efficiently, honestly and fairly ☑ comply with licence conditions ☑ comply with financial services laws and take reasonable steps to ensure representatives comply with them ☑ have adequate resources available ☑ maintain competence

☑ have satisfactory compensation arrangements ☑ ensure representatives are adequately trained and competent ☑ have a complying dispute resolution system for retail clients, and ☑ have adequate risk management systems.

Conduct requirements Conduct requirements are binding on both the licensee and the adviser so they must be included in the compliance system. Conduct requirements under the Corporations Act cover: • dealing with clients’ money • handling clients’ other property • payment of money relating to insurance companies • prohibition of unconscionable conduct, and • priority given to clients’ orders and instructions. For penalties for misconduct, see (¶8-125).

¶8-290 Disclosure obligations when providing financial services When providing financial services to a client, a number of obligations arise between the provider of those services and the client, including the obligation to provide the client with a: • Financial Services Guide (FSG) (¶8-300) • Statement of Advice (SoA) (¶8-310) • Record of Advice (RoA) (¶8-315) • Product Disclosure Statement (PDS) (¶8-320). Each of these is discussed below. Conduct and disclosure obligations under Pt 7.7 Part 7.7 of the Corporations Act 2001 imposes a number of conduct and disclosure obligations on providers of financial product advice. Part 7.7 requires persons who provide financial product advice to retail clients to comply with certain conduct and disclosure obligations. The obligations vary depending on whether the advice is personal or general. RG 175 outlines the details of how an entity would go about complying with Pt 7.7.

¶8-300 The Financial Services Guide (FSG) What is an FSG? An FSG: • is similar to the former (pre-FOFA) advisory services guide (ASG) • discloses the services of the adviser to the client

• can consist of two or more documents given at the one time • can be updated by a Supplementary FSG (SFSG) authorised by the licensee. An SFSG must include a statement that acknowledges it is an SFSG and identifies the FSG it supplements, and • must be updated if there are any relevant changes. What is included in an FSG? An FSG given by advisers must include the following in a clear, concise and effective manner: • on the cover — it must be called a “Financial Services Guide” but can later be called an FSG • the date of the FSG • the name and contact details of the providing entity and its AFSL number (if applicable) • where the providing entity is an Authorised Representative, its name, contact details, the AFSL number of the authorising AFS licensee and a statement that the providing entity is the authorised representative of that licensee • a statement about the purpose of the FSG and, if appropriate, other disclosure documents that the client may receive, such as an SoA or PDS, together with a description of the purpose of these documents • the remuneration, commission and other benefits that the licensee, the adviser or any other associated person will receive from providing the financial services • information about any business relationship or other association between the licensee and the issuers of any financial products capable of influencing the licensee when providing financial services • details of the relevant internal and external complaints and dispute resolution schemes of the licensee, and • details about the kinds of compensation arrangements in place and whether these arrangements comply with s 912B. When to give an FSG? An adviser, as a representative of the authorising licensee, must give a retail client an FSG as soon as possible after it becomes obvious that the adviser will provide a financial service and, in any event, before a financial service is provided. If there is more than one licensee of the adviser, both are authorising licensees.

Tip It is an offence not to provide an FSG, so “the earlier the better” is the best rule.

When is an FSG not required? Regulatory Guide RG 175 provides examples of situations where an FSG is not required such as when: • the client is not a retail client • the financial service is a recommendation, sale or issue situation and the providing entity gives the client a PDS and a “statement” that together contain all of the information that an FSG would be required to contain (reg 7.7.02A)

• the financial service relates to an interest in a cash management trust, a basic deposit product; a noncash payment facility related to a basic deposit product • other situations expressed in s 940B, s 941C and reg 7.7.02. Secondary service providers exempt A secondary service provider is a licensee or authorised representative who provides financial services to retail clients via another person (the intermediary). Secondary service providers do not have a direct relationship with the retail clients who receive their services, so they may have difficulty complying with the retail client requirements of the Corporations Act. ASIC has granted FSG relief to help secondary service providers inform retail clients about the services they provide in a practical and cost-effective manner. ASIC has granted class order relief in the following ways: • General FSG relief — where an arrangement exists for an intermediary to give a retail client the secondary service provider’s FSG, and other conditions are met, the secondary service provider has relief from the consequences of failing to actually provide an FSG. This relief has applied since 1 July 2005. • FSG relief for experts — where an expert’s report is to be included in a third party’s disclosure document, the expert’s FSG may be included as a separate and clearly identifiable part of the expert’s report if other conditions are met. • FSG relief for arrangers — where a person arranging for the issue of a financial product by a product provider under an intermediary authorisation and other conditions are met, the arranger’s FSG can be included as a separate and clearly identifiable part of the product provider’s PDS. Disclaimers Section 951A of the Corporations Act voids any arrangement which attempts to waive compliance with any part of the FSRA relating to the provision of financial services. While it is possible to include disclaimers in contracts, any attempt to do this in a contract for the provision of a financial service to “optout” in effect of the disclosure provisions under the FSRA is not possible.

¶8-310 Statement of Advice What is an SoA? A Statement of Advice (SoA) sets out the advice. Advisers must give a retail client an SoA, which can either be the means of giving the advice or a separate record of it. When to give an SoA? The adviser must give the client an SoA when giving personal advice to a retail client. It must be given prior to any action that would implement the advice, such as signing an application for a product. Generally, if an SoA is not required at the time advice is given, certain information must still be given at that time. In time-critical cases, the SoA must generally be provided within five days of the provision of the financial service or before the start of the cooling-off period.

What must be included in an SoA? An SoA must include statements of the following in a clear, concise and effective manner: • the title “Statement of Advice” on the cover or at or near the front of the document • the name and contact details of the providing entity and its AFSL number • where the providing entity is an authorised representative, the name and contact details of the AFS licensee and its AFSL number and a statement that the providing entity is an authorised representative of that licensee • the advice • the basis on which the advice was given • information on the remuneration and benefits anyone may receive • information on associations that might reasonably be expected to be, or have been, capable of influencing the providing entity to give the advice (note that notwithstanding this disclosure, advisers are required to prioritise their client’s interests over their own) • details of any interests, associations or relationships that might reasonably be expected or capable of influencing that advice.

Tip Cross-check with the FSG to ensure the information in the SoA is consistent.

Incorporation by reference There is no need to include a statement or information other than the statutory information if: • the SoA refers to the information or documents that has already been provided to the client • the client can identify the document (or the part of the document) that contained the relevant information by a “unique identifier” (eg Statement of Advice dated 1 June 2013, para 4). It might help to number the paragraphs in SoAs • the SoA provides sufficient information about the other document to enable the client to decide whether to obtain a copy of it or read it • the SoA states that a copy of the statement or information may be obtained from the providing entity on request and without charge.

Tip Advisers should ensure that they can substantiate that the client had access to the document being referenced.

Replacing one product with another (switching) If the advice includes a recommendation that the client disposes of, or reduces their interest in, one

product and replaces it with another, the SoA must include additional information, including RG 175.156– RG 175.157: • that the client’s existing product has been considered • the benefits and disadvantages, including costs and risks, of both products or investment options • any costs and charges payable for the disposal or reduction of the existing product • any charges for the new acquisition • any benefits that the client may lose, as a result of the disposal or reduction (eg insurance cover or access to product discounts) • the entry and ongoing fees applying to the replacement product and where the costs have increased, clear demonstration of additional benefits provided as a result of the replacement • any other significant consequences of the switch for the client, and • setting out reasons as to why the client will be in a better position following the switch. Where a client has been advised to replace one product with another, ASIC will consider the advice inappropriate if the providing entity knew (or ought to reasonably have known) that the overall benefits likely to result from the new product would be lower than the former product. ASIC will take into account the circumstances as well as the training required by RG 146. Disclaimers Section 951A of the Corporations Act voids any arrangement which attempts to waive compliance with any part of the FSRA relating to the provision of financial services. While it is possible to include disclaimers in contracts, any attempt to do this in a contract for the provision of a financial service to “optout” in effect of the disclosure provisions under the Corporations Act is not possible. When is an SoA not required? An SoA is not required: • where the advice is provided to a client who is not a retail client • where the advice relates to a cash management trust, basic deposit product, non-cash payment product related to a basic deposit product or traveller’s cheques • where the advice relates to general insurance (other than sickness and accident or consumer credit) • in the case of further advice (refer section on further advice below) • for advice over the telephone on traded products. This is subject to the client’s approval that an SoA is not required and that the provider of the advice will give the client an FSG. Time critical cases — delayed provision of SoA In time critical cases, advice can be provided to a client before an SoA is provided, where: • the client expressly instructs that the financial service be provided immediately, or by a specified time, and • it is not reasonably practical to provide the client with an SoA before the financial service is provided. The SoA must, however, be provided as soon as practicable and in any event within five days of providing the financial service. However, it is necessary to provide details of any conflicts of interest and remuneration that will be received as a result of the advice. The time-critical time limit was extended to 30 days for a period of six months under the ASIC

Corporations (COVID-19 — Advice-related Relief) Instrument 2020/355 — among other measures. Further advice Regulation 7.7.10AE provides for the use of a ROA, as described below, instead of the need to provide an SoA when: • the client has previously received an SoA that set out the client’s relevant personal circumstances in relation to the advice • there is no significant difference in the client’s personal circumstances currently to that previously considered • the basis on which the further advice is given is not significantly different. It is necessary to provide details of any conflicts of interest and remuneration that will be received as a result of the further advice, and to keep a record of the advice (see ¶8-315). Example SoA for life insurance In May 2017, ASIC released Consultation Paper 284 Example Statement of Advice for life insurance: Update to RG 90. The consultation paper sought feedback on the new example SoA and related updates to guidance in Regulatory Guide 90 Example Statement of Advice: Scaled advice for a new client. ASIC had produced various pre-FOFA sample SoAs and in August 2013 produced a FOFA-compliant version at 13 pages. Despite the examples being produced, the industry was producing SoAs post-FOFA that were between generally 20 and 100 pages in length — many contrary to the requirements in s 946B(6), for failing to ensure the information is “presented in a clear, concise and effective manner”. ASIC released and updated RG 90 in December 2017. The advice industry has been critical of the example SoA because, while it has given licensees some guidance in what ASIC considers key inclusions in a disclosure document, it was based on a very simple risk insurance-only case study and was still 23 pages in length. It was viewed by many as not completely compliant in not adequately taking into account the explicit and implicit areas of advice (particularly more so now under FASEA) and the licensee’s requirements on disclosure of product relationships, disclaimers, etc. Scaled and single-issue advice has recently come back onto government’s radar with commentary from industry, ASIC and government supporting scaled advice outcomes for clients to improve access to professional advice, however juxtaposed with the requirements under the FASEA Code which require a full, holistic assessment of a person’s personal and financial situation before settling on a scaled outcome.

¶8-315 Record of Advice Where further advice is provided, a new SoA does not always need to be provided. Instead, a Record of Advice (RoA) may be provided where the following requirements are met (s 946B and reg 7.7.10AE): (a) the providing entity has previously given the client an SoA setting out the client’s relevant circumstances in relation to the advice (the “previous advice”) (b) the client’s relevant circumstances in relation to the further advice (taking into account the client’s objectives, financial situation and needs) are not significantly different from the client’s relevant circumstances in relation to the previous advice, and (c) the basis on which the further advice is given is not significantly different from the basis on which the previous advice was given. The RoA must comply with either of the following: • it must set out the advice given to the client by the adviser and the disclosure of remuneration, and any conflicts of interest. ASIC has indicated that this may be by way of keeping a recording of the

conversation, or • keeping a full file note of the conversation that clearly and unambiguously sets out the advice provided, and also includes a summary of the client’s relevant personal circumstances considered and a clear statement that these are as set out in a previous RoA or SoA (and these are clearly identified by date). The adviser must be reasonably satisfied that the client’s relevant personal circumstances as set out in the previous RoA or SoA have not changed. The RoA must be kept for seven years and made available to the client on request. Thus, it is important that licensees give specific consideration to the manner in which they apply the RoA requirements (for example, maintaining a file note or a computer-based checklist) so that it can be provided to the client if requested as well as ensuring that the information within an RoA complies with the requirements of the regulation. In demonstrating that an adviser has complied with the statutory best interest duty, it is particularly important that a file note or RoA be prepared whenever a client conversation occurs.

Tip It is good practice to have the RoA signed and dated by both the client and the adviser.

$15,000 exemption from SoA or RoA Where advisers are advising clients on investments or superannuation amounts under $15,000 then, an SoA (or RoA) will not be required.

Tip Consumer protection mechanisms remain in place and financial advisers are still required to have a reasonable basis for their advice irrespective of the amount.

¶8-320 Product Disclosure Statement (PDS) What is a PDS? The role of a PDS is to provide clients with sufficient information to make an informed decision about whether or not to buy a financial product. It must be prepared by the product issuer and be dated. It is similar to the previous prospectus requirements. A PDS can consist of more than one document, provided that all are given at the same time and the fact that more than one document is identified clearly. Additional or updated information can be provided by a Supplementary PDS (SPDS). A PDS must not be altered except via an SPDS. What is included in a PDS? The contents of a PDS give full particulars of the product including the following details: • it must be entitled “Product Disclosure Statement” on the cover, but PDS can be used elsewhere • significant risks of the product • fees, expenses and charges

• taxation implications, and • any other information that could influence the client. Changes to fee disclosure requirements for superannuation and managed investment funds In August 2017, ASIC announced changes to the way superannuation and managed investment funds would need disclose fees and charges. The changes took effect from 30 September 2017 and helped to bring industry-wide consistency to exactly what must be included in the product disclosure statement (PDS). The changes will also ensure that the information in a PDS and periodic statements will match more clearly. The new requirements follow ASIC Report 398 Fee and cost disclosure: Superannuation and managed investment products which identified the following key issues: • under disclosure of fees and costs associated with investing indirectly through other vehicles • tax treatment of fees and costs • performance fees • under disclosure of management costs. ASIC has published Regulatory Guide RG 97 Disclosing fees and costs in PDSs and periodic statements along with Information Sheet 197 Fee and cost disclosure requirements for superannuation trustees (withdrawn 29 November 2019). In January 2019, ASIC released Consultation Paper (CP) 308 setting out their response to the recommendations in Report 581 Review of ASIC Regulatory Guide 97: Disclosing fees and costs in PDSs and periodic statements (REP 581). Feedback was sought on a draft updated RG 97 Disclosing fees and costs in PDSs and periodic statements (draft updated RG 97) and proposed amendments to Sch 10 to the Corporations Regulations (draft amendments to Sch 10). Following the updates to RG 97 in November 2019 and associated legislative instrument, ASIC made minor technical amendments to clarify its position on policy issues and amend the PDS transition arrangements (see below). Modifications to legislative obligations described in RG 97 are made in ASIC Corporations (Disclosure of Fees and Costs) Instrument 2019/1070. This instrument sets out the requirements that apply if an issuer adopts the requirements early or following the end of the transition period, described below. The transitional version of RG 97 (released March 2017) continues to be relevant during the transition period. However, the revised version of RG 97 (released November 2019, updated July 2020) provides clearer guidance about existing fees and costs disclosure requirements that have not changed from March 2017. It explains the information that superannuation trustees must disclose about fees and costs, including: • What are the fees and costs disclosure requirements? • What definitions have been introduced or amended under Sch 10? • When the new disclosure requirements start? • The approach ASIC will take to the new requirements. • The PDS disclosure required for each MySuper product and Choice product. • The disclosure required for indirect costs. • How fee disclosure should be treated from a tax perspective?

• How performance fees should be disclosed? • How advice fees should be disclosed? Clients have the right to request further information to that in the PDS and to be advised by the issuer of any material change or significant event affecting a product purchased. Issuers must confirm the acceptance of an application. Disclaimers Section 951A of the Corporations Act voids any arrangement which attempts to waive compliance with any part of the FSRA relating to the provision of financial services. While it is possible to include disclaimers in contracts, any attempt to do this in a contract for the provision of financial services to “optout” in effect of the disclosure provisions under the FSRA is not possible. When to give a PDS Whenever an adviser recommends, issues or sells a product, the client must be given an up-to-date PDS on that product at or before the time that the advice is given (ie before taking action to apply for or transfer the product). The PDS can be: • given personally • sent to the person • sent to their agent at an address. The agent cannot be a licensee or a licensee’s adviser, or • sent by email or faxed to an address nominated by the client. Unlike a prospectus, a PDS does not have a limited life. In effect there is no time limit on the currency of the document. However, it must be replaced or supplemented if it becomes materially misleading or deceptive. A product issuer has an obligation to confirm an acquisition of a financial product under a PDS. Although there are some exceptions, this obligation has to be complied with as soon as practicable after the financial product is purchased. When is a PDS not required? A PDS is not required if the client: • has already received a PDS containing all relevant information and which is up to date • has access to up-to-date information, or • switches products. There are also other exemptions that may be applicable, for example, successor fund transfer for a superannuation fund. Cooling-off period A 14-day cooling-off period is similar to the previous position with life insurance products, but now has a wider impact. It now applies to: • investment life insurance products • managed investment products • superannuation products, and • RSA (retirement saving accounts) products.

If the client applies within this period, they can have the transaction cancelled and obtain a refund or rollover in the case of superannuation benefits, but not necessarily all of their money if the value of an investment-linked product has changed within the 14 days. The 14-day cooling-off period starts on the earlier of: • the date that any confirmation is provided to the holder after the transaction occurs, or • the end of the fifth day after the day the product was issued or sold to the client.

¶8-350 Tax-related advice In providing financial planning advice, a financial adviser will invariably have to consider the client’s tax position. An adviser might provide advice which includes such items as the tax deductibility of income protection insurance premiums, the tax effectiveness of making deductible personal superannuation contributions, assessing a client’s income tax liability or eligibility for a tax rebate such as the Senior and Pensioners Tax Offset (SAPTO), or the assessment of a capital gains tax liability on the sale of an asset. Under s 90.5(1) of the Tax Agent Services Act 2009 (TASA), these activities can be considered a tax agent service: 1) A tax agent service is any service: a) that relates to: i) ascertaining liabilities, obligations or entitlements of an entity that arise, or could arise, under a taxation law, or ii) advising an entity about liabilities, obligations or entitlements of the entity or another entity that arise, or could arise, under a taxation law, or iii) representing an entity in their dealings with the Commissioner, and b) that is provided in circumstances where the entity can reasonably be expected to rely on the service for either or both of the following purposes: i) to satisfy liabilities or obligations that arise, or could arise, under a taxation law ii) to claim entitlements that arise, or could arise, under a taxation law. Financial advisers are prohibited under s 50.5(2A) from providing a tax agent service if not appropriately registered. ASIC has released guidance on a financial planner’s obligations under the Corporations Act when providing tax-related advice to their clients. ASIC notes that financial planners are not required to have expert knowledge of every aspect of tax law. However, they should have adequate knowledge of the tax implications normally applicable to the financial products that advice is being provided upon. In addition, financial planners should also have a general knowledge of tax law and practice sufficient to enable them to identify any other material tax issues on which the client may require further advice. In RG 175.358–RG 175.359, ASIC considers that there are two possible ways that an adviser can provide appropriate advice when there are material tax implications that the client should consider that go beyond the adviser’s competence: • the advice can be based on competent tax advice given to the client by someone else — in which case, the adviser should ensure that it makes it clear in the SoA and in discussions with the client that it is assuming the tax advice is appropriate, rather than endorsing it, or • the advice can be limited to those matters on which the adviser is competent to advise — in which case, the adviser must take reasonable steps to ensure that the client understands the need for seeking tax advice from someone competent to provide it before following the advice.

Note that it is important for the adviser to be satisfied that the client understands that independent tax advice should be obtained before making any investment decision. Coverage of the Tax Agent Services regime History The Tax Agent Services Act 2009 (TASA) introduced a single national tax regime which replaced the six previous state-based Tax Agents’ Boards. This regime regulates the provision of tax advice and includes the following requirements. Financial planners are required to be registered through ASIC with the Tax Practitioners Board (TPB) to provide tax (financial) advice within the context of providing financial advice. A public register indicates: • the scope of services that can be provided by a financial planner is determined according to the type of registration held: – a financial planner can give factual tax information – a financial planner with an additional form of registration through the TPB can provide tax (financial) advice within the context of, and incidental to, financial planning advice – as is the case now, financial planners who are also tax agents registered under the Tax Agents Services Act can provide full tax agent services including preparation or lodging returns or representing a taxpayer in their dealings with the ATO. Financial planners who are registered to provide tax (financial) advice (within the context of financial planning advice) need to abide by tax specific obligations that also apply to registered tax agents including a code of conduct. Note that the tax (financial) advice able to be provided does not extend to the provision of preparing or lodging tax returns Financial planners who wish to obtain this registration will need sufficient competency to provide reliable tax (financial) advice within the context of financial planning advice. To attain these competencies, the adviser will need to have certain tax-related qualifications. From 1 July 2014, AFS licensees and authorised representatives who had registered as tax (financial) advisers were required to maintain professional indemnity (PI) insurance — which also covered tax (financial) advice — and complete continuing professional education that met the TPB’s requirements. The relevant TPB documents are: • TPB(I) 20/2014 What is a tax (financial) advice service? • TPB(EP) 05/2014 Professional indemnity insurance policy requirements for tax (financial) advisers • TPB(EP) 06/2014 Continuing professional education policy requirements for tax (financial) advisers. These are available from the TPB’s website www.tpb.gov.au. What happened when the AFS licensees or authorised representatives were registered? A registered AFSL holder could provide tax (financial) advice through its employees and/or directors during the notification and transition periods. Financial advisers employed by a registered AFSL holder can provide a tax (financial) advice service for at least the duration of the notification. From 1 July 2017 If an AFSL holder or authorised representative registers after 30 June 2017, or renews an expiring, “deemed” registration, it must, among other things, have a “sufficient number” of employees and/or directors who are registered as tax (financial) advisers. Offences

Civil penalty provisions apply for providing a tax (financial) advice service without meeting the TPB’s requirements with fines applicable to both individuals and companies. Note Licensees need to ensure that their professional indemnity policy covers tax (financial) advice.

TPB Code of Professional Conduct information sheets The TPB has released several information sheets, including: • TPB(I) 17/2013: Code of Professional Conduct — Reasonable care to ascertain a client’s state of affairs • TPB(I) 21/2014: Code of Professional Conduct — Confidentiality of client information • TPB(I) 28/2016: Code of Professional Conduct — Reasonable care to ascertain a client’s state of affairs for tax (financial) advisers • TPB(I) 29/2016: Code of Professional Conduct — Reasonable care to ensure taxation laws are applied correctly for tax (financial) advisers • TPB(I) 30/2016: Code of Professional Conduct — Having adequate arrangements for managing conflicts of interest for tax (financial) advisers • TPB(I) 32/2017: Code of Professional Conduct — Confidentiality of client information for tax (financial) advisers • TPB(I) 34/2018: Code of Professional Conduct — Acting lawfully in the best interests of clients for tax (financial) advisers.

ANTI-MONEY LAUNDERING AND COUNTER-TERRORISM FINANCING ¶8-370 Anti-money laundering and financing of terrorism What is money laundering? Money laundering is the process by which criminals use the financial system to hide the criminal origin of the proceeds of crime, turning “dirty” money into “clean” laundered money. Criminals undertake money laundering in order to reduce the risk of detection and confiscation by the authorities. Money laundering has three stages: • Placement: the process of inserting the proceeds of crime into the financial system. • Layering: moving the money around the financial system to hide its origin, for example, transferring the dirty money from one country to another. • Integration: withdrawal by, or payment back to, the criminals of laundered funds. This means that any of our businesses can be impacted by money laundering — not just those that deal in cash. Money laundering is just as serious as the underlying crimes that generate the money that is laundered. For example, criminals are less likely to engage in drug trafficking if they are unable to profit from it financially in a way that avoids detection. Preventing money laundering, therefore, can help prevent drug trafficking. How is financing of terrorism different from money laundering? Financing of terrorism differs from money laundering in two main ways: • Very small sums of money can do very large amounts of damage in the hands of a terrorist. For

example, a bomb that costs a few thousand dollars to make can kill and cause billions of dollars damage. • Although terrorists may finance their activities through crime, particularly fraud involving stolen cheques or fake or stolen credit cards, legitimate funds can also be misappropriated for terrorist financing. These attributes of terrorist finance show the importance of reporting all suspicious activity, even if the sum of money involved is relatively small. The AML/CTF Act The AML/CTF Act contains compliance measures affecting the entire financial services industry, including superannuation trustees, financial planners and accountants. Australia and 30 other countries have agreed on international anti-money laundering and counter-terrorist financing standards, which are overseen by the Financial Action Task Force on Money Laundering (FATF). The AML/CTF Act forms part of a legislative package that will implement the first tranche of reforms to Australia’s AML/CTF regulatory regime. Background The reforms are a major step towards: • enabling Australia’s financial sector to maintain international business relationships • preventing and detecting money laundering and terrorism financing by meeting the needs of law enforcement agencies for targeted information about possible criminal activity, and • bringing Australia into line with international standards, including standards set by the FATF. About the AML/CTF Act The AML/CTF Act covers the financial sector, gambling sector, bullion dealers and other professionals or businesses (reporting entities) that provide particular “designated services”. Implementation of the AML/CTF Act was staggered. The AML/CTF Act imposes a number of obligations on reporting entities when they provide designated services. These obligations include: • customer identification and verification of identity • record keeping • establishing and maintaining an AML/CTF program, and • ongoing customer due diligence and reporting (suspicious matters, threshold transactions and international funds transfer instructions). The AML/CTF Act implements a risk-based approach to regulation. Reporting entities will determine the way in which they meet their obligations based on their assessment of the risk of whether providing a designated service to a customer may facilitate money laundering or terrorism financing. Why do reporting entities need to report to AUSTRAC? AML/CTF Program Under the AML/CTF Act, AML/CTF programs are required for reporting entities. These programs enable entities to identify, mitigate and manage the risk of their products or services, facilitating money laundering and terrorism financing. There are three types of AML/CTF programs:

• Standard: for individual reporting entities. • Joint: reporting entities that are members of a business group. • Special: only for holders of an AFSL offering a “designated service” defined in the AML/CTF Act. For more information about the content of the AML/CTF programs, visit www.austrac.gov.au. Reports are submitted to AUSTRAC electronically Reports are to be submitted to AUSTRAC electronically. Paper reports are only accepted from reporting entities who submit less than 50 reports (of any type) per year. Self-Assessment Questionnaire AUSTRAC has produced a Self-Assessment Questionnaire (SAQ) to help the financial services sector, bullion dealers and gambling establishments meet their obligations under the anti-money laundering and counter-terrorism financing system. The SAQ is a practical tool to help industry track compliance, manage and reduce money laundering and terrorism financing risk. It is designed to help entities with their obligations under the AML/CTF and AML/CTF Rules to understand, self-assess and monitor their progress in meeting these requirements. These are available from AUSTRAC’s website www.austrac.gov.au. Transition from the FTR Act to the AML/CTF Act — reporting obligations Regulated entities who had been reporting to AUSTRAC under the Financial Transactions Reports Act 1988 (FTR Act) are now required to report under the AML/CTF Act. Customer due diligence New customer due diligence requirements took effect from 1 June 2014. These amendments are set out by amendment to the seven chapters of the AML/CTF rules below: • Chapter 1 (containing key terms and concepts) • Chapter 4 (relating to customer identification) • Chapter 5 (relating to a special AML/CTF program) • Chapter 8 (relating to Pt A of a standard AML/CTF program) • Chapter 9 (relating to Pt A of a joint AML/CTF program) • Chapter 15 (relating to ongoing customer due diligence) • Chapter 30 (relating to disclosure certificates). Complying with AML/CTF obligations Each reporting entity is required to submit an annual report to AUSTRAC by 31 March in respect of the year ended the previous 31 December. For example, the report lodged by 31 March 2017 was in respect of the calendar year ended 31 December 2016. In order to adequately complete the report there are a number of areas a reporting entity needs to consider in respect of its business. The report covers a number of areas. Compliance and management oversight Each reporting entity is required to nominate a designated AML/CTF compliance officer must demonstrate that there is systematic management oversight of its AML/CTF obligations. The minutes of the compliance committee should record the adoption of the AML/CTF program and it should also be ratified by the Board. An external independent review of the AML/CTF program is desirable.

Assessing customer risk An AML/CTF program is required to include appropriate controls and risk-based systems that enable a reporting entity to be reasonably satisfied that the customer is who they claim to be. The Know Your Customer (KYC) procedures should enable it to identify and determine the risk level of each client, and to record this on the client’s file. Once the risk level is determined, this will then set the identification information that needs to be collected from the client and then verified and recorded on the client file. The process to assess a client’s risk level should include: • considerations of the client type and the jurisdiction in which the client is based, as well as whether an individual client or, for a company its ultimate beneficial owner is a politically exposed person (PEP) • the clients’ source of wealth • the nature and purpose of the company’s business relationship with each client type, and • the control structure of non-individual clients (including beneficial owners). Procedures should also exist and be documented as to how any changes to the ultimate beneficial owner is identified and then reassessed. Ongoing due diligence After the initial assessment reporting entities are required to monitor all of their clients and their transactions on an ongoing basis. The mandatory requirements of ongoing client due diligence are implementing: • the point at which additional KYC information needs to be collected, or compliance checks are undertaken for all clients, (not just for high-risk clients). For some reporting entities this is a monetary limit, while for others, it could be a request that funds are transferred to a third party beneficiary in another jurisdiction • a transaction monitoring program, in relation to suspicious transactions, and • an enhanced customer due diligence program. Reporting obligations Reporting entities are required to report to AUSTRAC to enable it to carry out its regulatory functions. The reports include: • international funds transfer instruction reports — These are to be submitted when a reporting entity sends or receives an instruction to or from a foreign country, to transfer money or property, to that entity • suspicious matter reports — These are required to be submitted if, at any time while dealing with a client, the reporting entity forms a reasonable suspicion that the matter may be related to an offence, tax evasion, or the proceeds of crime • threshold transaction reports — These are required to be submitted when a reporting entity provides a service covered by the Act to a client involving the transfer of currency (coin or paper money) or ecurrency of AUD10,000 or more (or the foreign equivalent), and • AML/CTF compliance report — This is required to be submitted annually to AUSTRAC by 31st March, which summarise the company’s AML/CTF activities for the previous calendar year. Initial and ongoing training It is important to ensure all employees who are involved in AML-related duties (such as identifying

customers, monitoring transactions, or processing funds transfer instructions) receive regular risk awareness training in relation to the reporting entities obligations under the Act and the Rules. Further, the content of the training should be tailored to reflect the unique money laundering and terror financing risks faced by the reporting entity. It is best practice for the training to be followed up with a written test for participants so that the AML/CTF compliance officer can assess the effectiveness of the training session and the knowledge levels of the employees. Changes to AML/CTF Rules Recent changes to the AML/CTF rules have: • changed how reporting entities are to collect “know your customer” (KYC) information for customers, and • set out requirements for reporting entities to rely on electronic verification methods. These changes affect Chapter 4 of the AML/CTF Rules, which has been replaced entirely. Collecting KYC information Until recently, reporting entities were required to collect KYC information “from” the customer. This has now been changed to a requirement to collect information “about” the customer. Previously, it was necessary to obtain all KYC information directly from the customer, and then to verify it. It is now permissible to use the verification document (such as a passport or drivers licence) to both collect and verify the KYC information in one step. Electronic Verification The AML/CTF Rules now permit electronic verification using reliable and independent data which offers an opportunity for reporting entities to streamline its processes by eliminating the need for customers to provide copies of identification documents which then have to be retained and managed. Previously, reporting entities were permitted to utilise electronic verification methods for medium or lower risk customers in order to meet the KYC information verification requirements, provided they verified: • the customer’s name and residential address from at least two separate “reliable and independent” data sources, and • either: – the customers date of birth from at least one independent data source, or – the customer had a transaction history for at least three years. Practically, there were a limited number of data sources that maintained this combination of name and address and date of birth. The amendments have modified this requirement so that, now, the electronic verification safe harbour allows individual customers to be verified by checks of: • the customer’s name, and either • residential address, or • date of birth, or • that the customer has a transaction history for at least three years. Importantly, verification of name, residential address or date of birth still requires two separate data sources. Verification of transaction history requires only one data source. Reporting entities, while not necessarily required to update their AML/CTF programs in light of these changes, should consider whether they trigger the review provisions in their program. If so, whether they

should take the opportunity to amend it so as to streamline customer due diligence processes and/or electronic verification procedures. Complying with KYC requirements during COVID-19 In May 2020, AUSTRAC provided updated policy and examples on its website to assist customer identification and verification during COVID-19 where face-to-face meetings with clients are compromised by the prevailing conditions. AUSTRAC amended its rules to “enable flexible KYC processes during the pandemic and provided that advisers can rely on alternative proof of identity processes: • where you can’t verify information based on the original, or a certified copy or certified extract, of a document usually relied on as part of your applicable customer identification procedures because of measures to prevent the spread of COVID-19. In such cases you may rely on a copy of that document. • where your customer can’t provide the identity documents you would usually rely on for applicable customer identification procedures because of measures to prevent the spread of COVID-19. This may include where customers are in self-isolation or where businesses have temporarily shut down. AUSTRAC intends to repeal these amendments following the conclusion of the COVID-19 pandemic. When determining the timing, AUSTRAC will consider the extent to which the Commonwealth, State and Territory Governments are still mandating social distancing and quarantine measures to prevent the spread of COVID-19. If entities choose to verify a customer’s identity using the above options, they should still apply the riskbased systems and controls in the AML/CTF program”. Source: www.austrac.gov.au/business/how-comply-and-report-guidance-and-resources/customeridentification-and-verification/kyc-requirements-covid-19 Anti-Money Laundering and Counter-Terrorism Financing Amendment Instrument 2018 (No 1) The Anti-Money Laundering and Counter-Terrorism Financing Amendment Instrument 2018 (No 1) (the Instrument ) amends the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 and the Financial Transaction Reports Act 1988 to strengthen Australia’s capabilities to address money laundering and terrorism financing risks and introduce regulatory efficiencies. The Instrument contains amendments to: • expand the objects of the AML/CTF Act to reflect the domestic objectives of AML/CTF regulation • close a regulatory gap by regulating digital currency exchange providers • provide regulatory relief to industry by: – clarifying due diligence obligations relating to correspondent banking relationships and broadening the scope of these relationships – de-regulating the cash-in-transit sector, insurance intermediaries and general insurance providers – qualifying the term “in the course of carrying on a business”, and – allowing related bodies corporate to share information • strengthen AUSTRAC’s investigation and enforcement powers by: – giving the AUSTRAC CEO the power to issue infringement notices for a greater range of regulatory offences, and – allowing the AUSTRAC CEO to issue a remedial direction to a reporting entity to retrospectively comply with an obligation that has been breached

• give police and customs officers broader powers to search and seize physical currency and bearer negotiable instruments (BNI) and establish civil penalties for failing to comply with questioning and search powers • revise the definitions of “investigating officer”, “signatory” and “stored value card” (SVC) in the AML/CTF Act, and • clarify other regulatory matters, including: – granting the AUSTRAC CEO a power to perform tasks that are necessary or incidental to his or her functions, and – the weight given to money laundering and terrorism financing risk in certain decisions made by the AUSTRAC CEO.

CONSUMER PROTECTION ¶8-400 Overview of consumer protection Advisers must abide by the laws covering consumer protection and restrictive trade practices. Consumer protection

Must not engage in/make: – Misleading or deceptive conduct or conduct likely to deceive or mislead – False or misleading representations in promotional material – Conduct likely to mislead as to nature, characteristic or suitability of a financial service – Unconscionable conduct – Accepting payment where intending to supply materially different services – Harassment and coercion or physical force – Inertia selling — asserting right to payment for unsolicited financial services

Restrictive trade practices

Prohibited conduct: – Price fixing and exclusive dealing – Third line forcing – Primary boycotts with exclusionary provisions – Resale price maintenance Conduct requiring ACCC approval: – Agreements affecting competition – Covenants running with land – Covenants in relation to prices – Secondary boycotts – Misuse of market power – Exclusive dealing – Mergers

Corporations Act 2001

– Provide services efficiently, honestly and fairly – False or misleading statements – Misleading and deceptive conduct – Display AFSL number on certain documents – Restricted words or expressions – Must not hawk products to retail clients

Other laws

– Promotional emails require recipient consent – Passing off

¶8-405 Misleading and deceptive conduct Introduction The main consumer law protections against misleading and deceptive conduct are found in the Competition and Consumer Act 2010, known as the Australian Consumer Law (ACL). It replaced the Trade Practices Act 1974 with effect from 1 January 2011. Offences are investigated and handled by the Australian Competition and Consumer Commission (ACCC). Consumer protection laws applying to financial planning are specifically contained in the Australian Securities and Investments Act 2001 and the Corporations Act 2001. The administration of these laws is undertaken by ASIC and these are discussed below. Penalties for non-compliance Penalties for non-compliance are severe. According the Australian Competition and Consumer Commission (ACCC) the maximum penalties per breach of the ACL including unconscionable conduct, making false or misleading representations, and supplying consumer goods or certain services that do not comply with safety standards or which are banned: For corporations, it will be the greater of: • $10,000,000 • three times the value of the benefit received, or • 10% of annual turnover in preceding 12 months, if court cannot determine benefit obtained from the offence. For individuals: • $500,000 • infringement notices Where the ACCC has reasonable grounds to believe a person has breached the provisions of the ACL it can issue an infringement notice in respect of the following: • unconscionable conduct • false or misleading conduct • pyramid selling • certain product safety and product information provisions • failure to respond to a substantiation notice • false or misleading information in response to a substantiation notice. The penalty amount in each infringement notice will vary, depending on the alleged contravention, but in most cases is fixed at: • $13,320 for a corporation (or $133,200 for a listed corporation), and • $2,664 for an individual for each alleged contravention. There are a range of other penalties and fines that the ACCC can apply (www.accc.gov.au/business/business-rights-protections/fines-penalties). A person affected by the conduct may obtain an order for damages and/or injunctive relief, plus a range of other orders. Also, ASIC can seek various court orders. Adviser found guilty of misleading and deceptive conduct

The Supreme Court of Western Australia ruled against an adviser taken to court over “misleading and deceptive” conduct, ordering her to pay nearly $3m in damages. The adviser was taken to court by her former client over tax advice the adviser had provided in relation to options exercised by the client’s wife. According to court documents, the adviser indicated to the client he had “a substantial liability to pay income tax” after his wife exercised 500,000 options on a mining company, and advised him throughout 2007 and 2008 to make a number of negatively geared investments to reduce this liability. The court found that the “premise on which [this] advice was based . . . was flawed”, and that the client incurred numerous losses as a result of the advice he received. The court ruled in favour of the client, finding that the adviser had breached the duty of care owed to the client and provided advice on a complex issue that fell outside her area of expertise. The court awarded damages of nearly $3m (Lockyer v Bermingham [No 3][2018] WASC 61). Misleading and deceptive conduct and statements Misleading or deceptive conduct, or conduct which is likely to mislead or deceive, is prohibited. Key elements There must be an occurrence of conduct which misleads, or is likely to mislead. Conduct may be: • making a statement, whether orally or in writing • doing something, or • failing to say or do something where something needs to be said or done to prevent someone from being misled.

Caution Conduct misleads when it leads someone to believe something which is false.

Important points to note are as follows: • conduct may be intentional or inadvertent • it is not necessary that anyone is actually misled so long as there is a real chance of someone being misled • the test is not what you think — it is the impression other people get • it is enough that a gullible, not so intelligent or poorly educated person is misled • a statement may be accurate, but when taken in context, amount to misleading conduct, and • a disclaimer does not absolve liability where the conduct as a whole is still misleading. Examples of misleading and deceptive conduct Scenario Sale of a business

Conduct or statements that could be deemed to be misleading or deceptive – Misrepresenting the past turnover of the business, or assets under administration

– Making predictions about the likely future turnover or growth of the business without reasonable grounds Advertising

– Saying or implying that our services are superior to our competitors (or that theirs are inferior) when this is not the case – Comparing services, which are not really equivalent – Falsely implying that our services are endorsed by or associated with a well-known person, character or organisation – Advertising, brochures, labels, pricing and packaging, which contain product claims or information that is incomplete, out of date or misleading. What is left out may be just as damaging as what is put in – Note: Courts generally take a more robust approach when considering advertising because it is accepted that the public is aware that advertisers are presenting their services in a favourable light. Courts will draw a line between mere “puffs” or exaggerations, and misleading conduct. However, comparative advertising is a high-risk area and should be carefully considered before it is engaged in

Pricing of business

– Not including the full terms and conditions/all necessary qualifications when providing quotes – Quoting GST exclusive prices or failing to mention additional costs without drawing attention to this fact

Silence

– Knowing that a customer mistakenly believes that a deal gives them particular rights when you know it does not, and keeping quiet about it

False representation in relation to services

– Making statements that services have a particular standard quality or grade or suitability for their purpose when it is not the case

Predictions

– Making predictions, such as predictions to customers about how well products will be received in the market, when there is no reasonable basis for them

Distribution of misleading material prepared by others (eg supplier, clients)

– Can amount to misleading conduct by the person distributing the material, unless the person makes it clear that they are merely passing on the material and are not confirming its accuracy

Dos and don’ts Do

Do not

– Ensure that all advertising and other promotional – Do not make any misleading statements. Make material is not misleading sure that you can substantiate all statements with actual proof – Ensure that everything you say about our services is not only accurate, but also unlikely to mislead anyone

– Do not remain silent when it is necessary to say something to prevent someone from being misled

– Seek advice if you are concerned that proposed statements or conduct may be misleading

– Do not make predictions when you don’t have any reasonable basis for them

– Seek advice if you think you may be suffering as a result of someone else’s misleading conduct

– Do not hand out material prepared by others without checking its accuracy

¶8-410 Fair trading and the Australian Consumer Law The laws require advisers to treat people fairly and give them accurate information. From 1 January 2011, the state fair trading acts were replaced with the national Competition and Consumer Act 2010, known as the Australian Consumer Law (ACL). The laws focus on:

• misleading or deceptive conduct • unconscionable conduct, and • unfair contract terms, and impact advisers when dealing with the public as well as clients. The fair trading provisions of the ACL prohibit a number of practices for financial advisers.

Tip A great deal of the ACL fair trading laws are labelled “consumer protection”, but a consumer can be a business under s 3 of the ACL, eg where a business acquires goods or services priced under $40,000, or items over $40,000 and normally bought for personal, domestic or household use or consumption or vehicles and trailers used mainly to transport goods on public roads.

Overview of fair trading laws in the ACL The following table provides an overview of the ACL provisions and how advisers should act to comply with the law. ACL fair trading provisions

How to act?

Giving the wrong impression (misleading/deceptive – Tell the truth and state the full facts — leaving conduct) gaps can be misleading – The adviser’s intention is irrelevant — ensure the client fully understands Advisers must not: – do or say anything that will give other people the wrong impression – mislead anyone or engage in deceptive conduct

– The test is what impression the other person gets not what the adviser thinks – Avoid fine distinctions, legal and technical terms – Do not predict future events or returns without real evidence – Make sure all statements and figures in documents can be supported by evidence – Make sure clients know who they are dealing with

Unfair treatment (unconscionable conduct)

– Treat people fairly, as an average person would understand that – Ask “Would we be happy to see this on the front page?”

Advisers must not use their power or position – Ask “Would I like to see my family treated the unfairly (note also an adviser’s requirements under same way?” the FASEA Code) – Do not take advantage of other people’s disadvantages, such as: – poor English or illiteracy – age or infirmity – lack of business experience – being dominated by someone else – anything else that is a disadvantage in common sense – does the client understand? — ask questions to find out

False statements (misrepresentations)

Avoid false statements regarding: – services being of a particular standard, value or grade – that a particular person has agreed to acquire services

Advisers must not make: – specific false or incorrect statements, or

– sponsorship, approval, performance, uses or benefits that your company, yourself or a service does not possess

– misrepresentations in connection with the supply – the price of services of services – the need for any services – the existence of a warranty or guarantee. Do not make a statement without checking them Other illegal actions

– Do not harass people at home or at work – Do not cold-call outside prescribed hours – Do not offer gifts or prizes unless they can and will be given – State the full price when stating part of the price – Only accept payment for services if there is intention on supplying the service

A court can order any one or more of the following: • injunctions preventing the company doing future acts that may breach the law • compensation for any person who loses money from a breach of the law • actions for damages against the company • community service orders to create public awareness or provide industry summary material • disclosure orders to distribute information, such as profits made from illegal activities (and thus help people who want to sue) • probationary orders requiring further steps to prevent future breaches, or • adverse publicity orders about relevant breaches to “shame” the company. Unfair contract terms The ACL prohibits the incorporation of unfair terms in consumer contracts. A contract term is unfair if it: • would cause significant imbalance in the parties’ rights and obligations arising under the contract • is not reasonably necessary in order to protect the legitimate interests of the party who would be advantaged by the term, and • would cause detriment (whether financial or otherwise) to a party if the term were to be applied or relied on. Unfair contract terms relating to financial products including credit are regulated by similar provisions in the ASIC Act. National Consumer Credit Law History A new single national consumer credit law framework commenced on 1 November 2009. The National Consumer Credit Protection Act 2009 (NCCP Act) created the Australian Credit Licence, putting in place “one, single, standard national regime to support a national consumer credit market”.

The legislation incorporated the Uniform Consumer Credit Code (UCCC), and extended the regulation of consumer lending to include loans to individuals to purchase residential property for investment purposes, as well as to provide for the regulation of credit providers, finance brokers and other intermediaries. The legislation also made membership of an external dispute resolution (EDR) scheme compulsory and established a new regime of disclosure to consumers for both credit providers and finance brokers. The laws involve two issues for assessing whether credit is being extended responsibly: (1) assessing the unsuitability of a credit product for an individual, and (2) assessing a person’s capacity to repay the proposed credit debt. The licensing regime is overseen by ASIC. Impact on financial advisers Financial advisers may be impacted by the regime if they provide advice to their clients such as the following: • to reduce interest payments by consolidating loans • to reduce credit card commitments by either paying the debt off or consolidating to fewer cards for easier management • to rebalance a client’s portfolio involving residential or commercial properties, and look into the loan criteria and suggest possible ways of maximising cash flow • to reduce all debts by accelerating their repayment schedule • to use a revolving line of credit facility • to open an offset account and use this to reduce the interest payment calculation. All persons engaging in credit activities must either have their own credit licence or be a representative of a credit licensee.

¶8-415 Restrictive trade practices Introduction The Competition and Consumer Act 2010, known as the Australian Consumer Law (ACL), regulates anticompetitive and misleading or deceptive trading practices. Part IV of the ACL specifically prohibits specific restrictive trade practices. As indicated in ¶8-405, the ASIC Act regulates consumer protection in respect of financial services. Thus, for financial services it is only the restrictive trade practices provisions contained in the ACL which apply. Some restrictive trade practices are prohibited outright and the remainder prohibited only if they substantially lessen competition without public benefit. Penalties for non-compliance The penalties and consequences for non-compliance include: • fines/damages: – up to of $10m per offence for companies, o If the court can determine “reasonably attributable” benefit obtained, three times that value, or o If the court cannot determine benefit, 10% of annual turnover in preceding 12 months. – $500,000 for individuals

• reputational damage • imprisonment of individuals aiding and abetting illegal practices • diversion of management time, or • legal costs. Conduct prohibited outright Scenario

Conduct that could be deemed to be restrictive

Price fixing

Arrangement with a competitor to fix, control or maintain prices, discounts, rebates or credits for goods and services

Tying of products (also known as third line forcing)

A supplier only supplying a product to a buyer if the buyer agrees to acquire goods or services from a third person (eg saying that a client can only buy a managed investment product if the client also gives the same group their household insurance)

Primary boycotts with exclusionary provisions

Agreements, arrangements or understandings the purpose of which is to restrict the supply or acquisition of goods and services (eg you and a competitor agree not to use Z’s services because Z has a record of failure to deliver on time)

Resale price maintenance — deals with competitors

Agreeing with competitors only to sell certain products or supply goods on condition that the purchaser restrict its dealing (eg not acquire goods or services from a competitor)

Conduct requiring ACCC approval In the scenarios summarised below, it needs to be shown there is no substantial lessening of competition or that the public benefit outweighs the anti-competitive detriment for the ACCC to approve the conduct. This is a complex area and there are substantial penalties and significant cost involved in submitting a case for possible authorisation to the ACCC. Scenario

Conduct that could be deemed to be restrictive

Agreements affecting competition

Agreements to allocate or divide customers, territories or sales which has the effect of creating a monopoly where competitors and hence price competition is absent

Covenants running with land

A vendor sells two adjoining blocks to different purchasers — Block 1 to a hotel, Block 2 to a shopping centre developer — with a covenant that the purchaser will not apply for a liquor licence. This restriction would breach the ACL.

Covenants in relation to prices

Practices which produce the same effect as price fixing even if not formally described as such if it has the effect of substantially lessening competition unless public benefit outweighs the anti-competitive detriment

Secondary boycotts

This refers to a concerted action by A and B, who engage in conduct which hinders C to prevent C from supplying, acquiring from or otherwise dealing with D

Misuse of market power

A corporation, big or small, that possesses “a substantial degree of power in a market”, takes advantage of that power for eliminating or substantially damaging a competitor, preventing the entry of a person to that market, or deterring or preventing a person from engaging in competitive conduct

Exclusive dealing

The practice whereby buyers and sellers deal subject to a condition which restricts the buying or selling decisions of their customers or suppliers

Mergers

Mergers which substantially lessen competition in a market are prohibited

The following table provides an overview of restrictive trade practices and suggested ways to avoid such practices. What activities amount to restrictive practices?

How to act?

Price fixing

Advisers should not discuss any aspect of prices with competitors — “prices” includes commissions and discounts

Deals with competitors

Advisers should not make deals with competitors. Some arrangements may be acceptable, but others will not be. Generally it is best to compete and avoid any type of restrictive deals

Tying one product or service to another

Products or services should not be tied to one another, including through discounts or other indirect means, without first determining that this is not a restrictive practice

Agreements on who to deal with

Avoid all blackbans or boycotts of anyone, including agreeing who should be treated as a bad credit risk

Unfair contract terms Amendments have been enacted to the TPA which prohibit the incorporation of unfair terms in consumer contracts. A contract term is unfair if it: • would cause significant imbalance in the parties’ rights and obligations arising under the contract • is not reasonably necessary in order to protect the legitimate interests of the party who would be advantaged by the term, and • would cause detriment (whether financial or otherwise) to a party if the term were to be applied or relied on. (Previously this was just a factor that the court had to take into account — now the term must cause detriment to be found unfair.) A “consumer contract” is a contract for the supply of goods or services (or sale or grant of an interest in land) to an individual whose acquisition of the goods, services or interest is wholly or predominantly for personal, domestic or household use or consumption. Unfair contract terms relating to financial products including credit are regulated by similar provisions in the ASIC Act. Note for AFSL holders This legislation is important for anyone who conducts business through unsolicited marketing such as advisers and licensees cold-calling prospects as it standardises the requirements under federal legislation. Because s 736, 992A and 992AA of the Corporations Act 2001 (Cth) prohibit the hawking of securities, certain financial products and managed investment products, the unsolicited selling of these financial services and products are excluded from the operation of the unsolicited selling provisions of the Competition and Consumer Act 2010, known as the Australian Consumer Law (refer ¶8-420).

¶8-420 Consumer protection under the Corporations Act 2001 The Corporations Act also has provisions that cover: • providing services efficiently, honestly and fairly • making false or misleading statements, and • engaging in misleading and deceptive conduct.

In addition, the following provisions apply: • AFSL number must appear on certain documents • restricted words and expressions must not be used unless strict tests are met • anti-hawking, and • professional indemnity insurance from 1 July 2008. Strengthened penalties for breaches of corporate laws The Treasury Laws Amendment (Strengthening Corporate and Financial Sector Penalties) Act 2019 strengthens existing penalties and introduced new penalties (including harsher civil penalties and criminal sanctions) for breaches of ASIC-administered legislation including: • Corporations Act 2001 • Australian Securities and Investments Commission Act 2001 • National Consumer Credit Protection Act 2009 and National Credit Code • Insurance Contracts Act 1984. ASIC notes that under the new penalty provisions: • maximum prison penalties for the most serious offences have increased to 15 years — including breaches of director’s duties, false or misleading disclosure and dishonest conduct • maximum civil penalties for individuals and companies have significantly increased, and • civil penalties now apply to a greater range of misconduct — including a licensee’s failure to act efficiently, honestly and fairly, failure to report breaches and defective disclosure. Under the new penalty provisions, the maximum civil penalty for individuals is the greater of 5,000 penalty units (currently $1.11m) or three times the benefit obtained and detriment avoided. The maximum civil penalty for companies is the greater of: • 50,000 penalty units (currently $11.1m) • three times the benefit obtained and detriment avoided, or • 10% of annual turnover, capped at 2.5m penalty units (currently $555m). The value of a penalty unit is prescribed by the Crimes Act 1914 and is currently $222 for offences committed on or after 1 July 2020. AFSL number on documents It is a legal requirement that the AFSL number appears on the following documents: • Financial Services Guide (FSG) • Supplementary FSG (SFSG) • Product Disclosure Statement (PDS) • Supplementary PDS (SPDS) • Statement of Advice (SoA) • application form contained in a PDS

• document providing information about a superannuation fund • ongoing disclosure of material changes and significant events in a PDS. Anti-hawking The anti-hawking provisions of the Corporations Act are outlined in ASIC Regulatory Guide RG 38 and aim to prevent pressure selling of financial products to retail clients outside of permitted hours (“boiler room” practices). Penalties for non-compliance A breach of the hawking prohibitions is a criminal offence. The maximum penalties are: • a fine of $5,550 for an individual or $27,750 for the licensee • six months jail, or • both. The AFS licensee may also be suspended or revoked. In addition, the consumer may also have a right to return the product or undertake civil proceedings against the offeror. Hours permitted for hawking certain financial products The prescribed hours are from 8 am to 9 pm on a day excluding: • any Sunday • New Year’s Day • Australia Day • Good Friday • Easter Monday • Anzac Day • Christmas Day • Boxing Day. Professional indemnity insurance requirements Regulations were made in June 2007 regarding the consumer compensation arrangement obligations which financial services licensees are required to have in place (reg 7.6.02AAA of the Corporations Regulations 2001 and s 912B). The regulation specifies that the primary method of compliance with the compensation obligations is for licenses to obtain professional indemnity insurance. Licensees are responsible for assessing their business and ensuring that they have adequate insurance cover. The regulation introduced specific provisions enabling licensees to comply with their obligations to have adequate arrangements for compensating retail clients for losses they suffer as a result of breaches by a licensee of any of their obligations under the Corporations Act. The compensation requirements reduce the risk that a licensee cannot pay claims due to insufficient resources. The Regulations provided for transition periods so that licensees had time to assess their business and obtain professional indemnity insurance; however, all licensees are now required to have professional indemnity insurance in place. RG 126

RG 126 was updated in August 2017 and covers compensation for clients and sets out how AFS licensees should comply with the Corporations Act, and specifically refers to the compensating of clients after breaches covered in Ch 7. The primary means of compliance with this obligation is to have professional indemnity (PI) insurance cover. ASIC has administered the PI insurance framework to reduce the risk that retail clients are uncompensated where a licensee has insufficient financial resources to meet claims by retail clients. ASIC with RG 126 aims to: • administer compensation requirements to maximise their potential of reducing the risk that a retail client’s losses cannot be compensated because of lack of funds on the licensee’s part, and • improve the standard of PI insurance cover currently in place in the industry. Amount of PI cover required What is “adequate” PI cover? RG 126.51 addresses what is an adequate level of PI cover for licensees. Licensees are to hold PI insurance that is adequate, having regard to: • their liability for claims brought through their external dispute resolution (EDR) scheme in s 912A(2)(b) or (c) (see reg 7.6.02AAA(1)(a)), and • the nature of the financial services business carried on by the licensee, including: – the volume of business – the number and kind of clients – the kind or kinds of business, and – the number of representatives (see reg 7.6.02AAA(1)(b)). Amount of cover To be adequate overall, a PI insurance policy must have an adequate amount of cover. To be adequate, the limit of indemnity under the policy should cover a reasonable estimate of retail clients’ potential losses (RG 126.53). Minimum requirement (table 4 of RG 126) ASIC consider that, to be adequate, a PI insurance policy must have a limit of at least $2m for any one claim and in the aggregate for licensees with total revenue from financial services provided to retail clients of $2m or less. For licensees with total revenue from financial services provided to retail clients greater than $2m, minimum cover should be approximately equal to actual or expected revenue from financial services provided to retail clients (up to a maximum limit of $20m).

¶8-425 Other consumer protection laws Anti-spamming laws Spam is defined as “unsolicited commercial electronic messaging”. The Spam Act 2003 includes rules aimed at preserving legitimate business communication activities and encouraging the responsible use of electronic messaging. The following general principles apply: • “electronic messaging” covers emails, instant messaging, SMS and other mobile phone messaging, but does not cover normal voice-to-voice communication by telephone

• to be covered by the Spam Act, the message must be commercial in nature — for instance an offer to enter into a commercial transaction, or directing the recipient to a location where a commercial transaction can take place • a message is not automatically commercial if it contains a link to the company’s website in a footer • there are a large number of commercial electronic messages that can be sent legitimately • they are only considered to be spam if they are sent without the prior consent of the recipient as unsolicited messages, and • a single message may be spam. The message does not need to be sent in bulk, or received in bulk. The Spam Act makes no reference to bulk messaging — a single unsolicited commercial electronic message could be spam. Rules for sending commercial electronic messages Commercial electronic messages must contain: • accurate information about the sender of the message • sender’s contact details in email footer, and • a functional way for the message’s recipients to indicate that they do not wish to receive such messages in the future — that they wish to unsubscribe. You should ensure that your contact details are contained in your email signature. Penalties for non-compliance The maximum penalties under the Spam Act are substantial. A business that is found to be in breach of the Spam Act may be subject to a court imposed penalty of up to $220,000 for a single day’s contraventions. If a business is found to have breached the Act more than once, they may be subject to a penalty of up to $1.1m.

PRIVACY COMPLIANCE ¶8-510 Australian Privacy Principles — the APPs Privacy laws changes came into effect in 2014. The current legislation consists of a single set of Australian Privacy Principles (APPs) that applies both to Australian government agencies and the private sector (APP entities). The changes increased the Privacy Commissioner’s power and enhanced the functionality of the role. The changes also introduced large civil (monetary) penalties for breaches of the Act. To whom do the privacy laws apply? Businesses are affected by the changes to the privacy laws if they: • handle personal information and generate more than $3m in annual turnover, or • generate less than $3m but fit under a second set of criteria. Of this second set of criteria, the one which is most likely to affect small businesses is “trading in personal information”. Do you trade in personal information? It is likely that AFS licensees as a small business could trade in personal information.

Personal information is information that identifies, or could reasonably identify, an individual. This will include names, addresses, dates of birth and bank account details of clients or prospects. Trading in personal information includes collecting or providing personal information to a third party for a benefit, service or advantage. If an AFS licensee or authorised representative is collecting personal information and then providing it to a business (related or otherwise) to manage direct marketing or is using customer data to cross-sell products from a related business, it may be trading in personal information. Australian Privacy Principles (APPs) There are 13 APPs: APP 1 — Open and transparent management of personal information Ensures that APP entities manage personal information in an open and transparent way. This includes having a clearly expressed and up-to-date APP privacy policy. APP 2 — Anonymity and pseudonymity Requires APP entities to give individuals the option of not identifying themselves, or of using a pseudonym. Limited exceptions apply. APP 3 — Collection of solicited personal information Outlines when an APP entity can collect personal information that is solicited. It applies higher standards to the collection of “sensitive” information. APP 4 — Dealing with unsolicited personal information Outlines how APP entities must deal with unsolicited personal information. APP 5 — Notification of the collection of personal information Outlines when and in what circumstances an APP entity that collects personal information must notify an individual of certain matters. APP 6 — Use or disclosure of personal information Outlines the circumstances in which an APP entity may use or disclose personal information that it holds. APP 7 — Direct marketing An organisation may only use or disclose personal information for direct marketing purposes if certain conditions are met. APP 8 — Cross-border disclosure of personal information Outlines the steps an APP entity must take to protect personal information before it is disclosed overseas. APP 9 — Adoption, use or disclosure of government-related identifiers Outlines the limited circumstances when an organisation may adopt a government-related identifier of an individual as its own identifier, or use or disclose a government-related identifier of an individual. APP 10 — Quality of personal information An APP entity must take reasonable steps to ensure the personal information it collects is accurate, up-todate and complete. An entity must also take reasonable steps to ensure the personal information it uses or discloses is accurate, up-to-date, complete and relevant, having regard to the purpose of the use or disclosure. APP 11 — Security of personal information An APP entity must take reasonable steps to protect the personal information it holds from misuse, interference and loss, and from unauthorised access, modification or disclosure. An entity has obligations to destroy or de-identify personal information in certain circumstances. APP 12 — Access to personal information Outlines an APP entity’s obligations when an individual requests to be given access to personal

information held about them by the entity. This includes a requirement to provide access unless a specific exception applies. APP 13 — Correction of personal information Outlines an APP entity’s obligations in relation to correcting the personal information it holds about individuals. How to comply • undertake a quick audit review of your business to identify where and how you deal with personal information • establish or revise procedures and systems so that all staff that handles personal information complies with the privacy law changes • revise the Privacy Policy and ensure it includes: – the AFS licensee’s name – the AFS licensee’s contact details – the purpose for collecting the personal information – to whom the personal information will be disclosed – what personal information is to be collected – how the personal information will be collected – the purposes for which personal information is to be used and disclosed • provide a copy of the Privacy Policy to clients and prospects when you collect their personal information • if you use personal information for direct marketing, it should be disclosed and a way provided for clients and prospects to unsubscribe • if you disclose personal information to parties overseas, it is necessary disclose this and, if practicable, specify the countries where those parties are located • set out how you secure and store personal information. Penalties for breaching According to the Office of the Australian Information Commissioner, a range of civil penalty provisions in the Privacy Act may apply (depending on the nature of the breach) and can include: • a serious or repeated interference with privacy (s 13G) — 2,000 penalty units • various civil penalty provisions set out in Pt IIIA — Credit reporting, with penalties of either 500, 1000 or 2000 penalty units.

¶8-520 Adviser’s role in privacy compliance Privacy continues to be a dominant source of complaint in the industry. To ensure that advisers meet the obligations set out in the 13 APPs, they need to perform the following: • always adhere to the licensee’s compliance privacy policy • review what information is collected and how it is used. Is any information collected unnecessary?

• become familiar with the 13 APPs and how they apply to the adviser’s practice • attend training sessions on privacy • be careful of arrangements in joint parties where an adviser acts on behalf of both parties individually. Isolate information that relates solely to one party or a guarantor • adopt a clean desk policy at their workplace. Make sure client material is never in the view of other clients • secure all material and laptop when not in use • verify and follow up on all faxed or telephone requests • report any concerns to the Privacy Officer as soon as possible • use the standard documents and software issued by the licensee • work with the person who undertakes the monitoring of the privacy process to provide as much information to assist in determining their level of compliance • treat monitoring as an opportunity to learn more about their obligations and how best not to contravene them • respond promptly to any reporting issued from compliance monitoring, and • become active in promoting privacy compliance best practice within their business. Compulsory data breach notifications The Privacy Amendment (Notifiable Data Breaches) Act 2017 makes it mandatory for a wide range of organisations to notify to the Australian Information Commissioner and affected individuals when an eligible data breach occurs. Under the legislation, data breach notification may be required for events like a malicious breach of secure storage and handling of information (for example, a cyber security incident), an accidental loss (commonly of IT equipment or hard copy documents), or negligent or improper disclosure of information. An “eligible” data breach occurs if a reasonable person would conclude there is a likely risk of serious harm to any affected individuals because of an unauthorised access or disclosure. Serious harm could include physical, psychological, emotional, economic, reputational and financial harm. The notification requirement should prompt all businesses to examine their cyber security. The Office of the Australian Information Commissioner has a guide to assist organisations to develop data breach response strategies. Every organisation should consider their risk management strategies to avoid data breaches. They also should consider cyber liability insurance as a protection option.

COMPLAINTS HANDLING ¶8-600 The modern complaints handling system for financial advisers A feature of financial advising today is to give clients cost-free and efficient access to complaints and dispute resolution procedures. This enables client concerns to be fairly considered and errors to be rectified in a practical way. It also gives the client an effective remedy without having to become involved in the high risks and costs of litigation. ASIC has published RG 165 Licensing: Internal and external dispute resolution (updated May 2018).

¶8-610 How the adviser should act following a complaint Licensee will often give all relevant staff specific directions or procedures on how to act in relation to complaints. Those procedures should be followed. However, for general guidance, the following steps provide practical assistance on how to handle a complaint in the modern complaints handling system. How to handle a complaint Step 1: Decide if there is a complaint “Complaint” is defined as: “An expression of dissatisfaction made to an organisation, related to its products or services, or the complaints handling process itself, where a response or resolution is explicitly or implicitly expected”. It may be an enquiry rather than a complaint. An enquiry is a simple request for information. If it does not ask for or imply dissatisfaction, or a request for anything to be remedied, a response to the enquiry should be given promptly and nothing further is needed. If it is a complaint: • check that the complainant was informed about the complaints system. If they were not, give them a copy of the brochure for the complaints system or refer them to the relevant website • explain their rights to them, and where a complainant has limited literacy skills, the complainant should be assisted in filling in forms or given help in expressing their complaint more clearly • complaints do not need to be in writing and insisting that complaints are in writing can become a disincentive to the complainant, for example, if the complainant has poor writing skills. Note that the IDR procedure should enable complainants to make a complaint by reasonable means, for example, letter, telephone, in person or email. Complaints made by these means still constitute complaints • tell the complainant when they will receive a response, who will handle the complaint as well as provide contact details for that person • make a note in their file and pass the complaint to the contact person for complaints (complaints person). Step 2: The complaints person The complaints person will decide if the client’s complaint can be resolved immediately (ie by the end of the next business day). If so, it is the best solution and nothing needs to be done, except make a file note on the incident. However, it needs to be ensured that the complaint has been fully satisfied by making specific enquiry of the client in order to avoid, as far as possible, the complaint resurfacing. It will not be necessary to apply the full IDR process where the complaint is resolved by the end of the next business day although ASIC does encourage the application of the full IDR process where possible.

Note Complaints should be responded to in accordance with the urgency of the complaint. This involves prioritising complaints.

Step 3: What is the next step if the complaint cannot be resolved by the end of the next business day? • acknowledge receipt of the complaint immediately, or as soon as possible, including advice of response times to the complaint

• the complaint should now be dealt with in accordance with the IDR procedure, which as minimum should: – have a clear response time for dealing with complaints – have a contact point for complainants – nominate appropriately trained and competent staff to deal with those complaints, including the authority to settle complaints, or ready access to someone who has the necessary authority; and ensure adequate systems are in place to handle complaints promptly, fairly and consistently. Thus, for larger organisations with a large retail client base, ensuring adequate resources may include such matters as providing a toll-free call facility where complaints can be logged and appointing sufficient staff to deal with complaints. For smaller organisations, adequate resources might include a senior staff member who is available to deal with complaints • give/send the complaint to the contact point for complaints for attention in accordance with the IDR procedure. Do not attempt to conceal any complaint • make a note in the client file that this has been done and that the complaint is now being handled in accordance with the IDR procedure • the complaint should be addressed in an equitable, objective and unbiased manner through the complaints handling process. This requires that: – procedures should allow adequate opportunity for both parties to make their case – where possible, the complaint should be investigated by staff not involved in the subject matter of the complaint. Step 4: Making a decision and advising the client • in responding to a complaint, the organisation should give reasons for the decision and adequately address the issues that were raised in the initial complaint. Where practicable, the reasons for the decision should be in writing and should refer to applicable provisions in legislation, codes, standards or procedures • ASIC considers that a final response to a complaint should be made within a maximum of 45 days, however, it may be reasonable to consider shorter time frames for different types of complaints (eg administrative complaints, performance-related complaints and advice-related complaints) depending on the size of the organisation, the client base and the types of products and services offered under the AFSL • if a final response to the complainant cannot be made within 45 days, the complainant should be informed of the status of the complaint, the reasons for the delay, the right to complain to an EDR body, eg AFCA (¶8-615), and provide its contact details. Step 5: What happens if the client is still not satisfied? If the complaint is rejected, state the reason and remind the complainant of their right to take the complaint to the external dispute resolution (EDR) body, eg AFCA (¶8-615). • the EDR process may result in conciliation, arbitration or a decision • all parties have a right to be heard • the licensee may be billed by the external scheme • if the claim is not within the scheme’s jurisdiction, the client may need to seek redress from the courts • the EDR body’s decision is binding on the licensee and adviser.

Step 6: Court/regulator action • if the client is not satisfied with the EDR scheme’s decision, the client can take the matter to court • collaborate with the licensee on what action should be taken. Get legal advice before taking any action. Step 7: Analysis and evaluation of complaint and reports to management • all complaints should be classified and then analysed to identify systemic, recurring and single incident problems and trends. This will help eliminate the underlying causes of complaints • to do this it will be important to analyse complaints according to categories, such as type of complaint, outcome of complaint and timeliness of response • it is necessary to have a complaints system which specifies the steps for identifying, gathering, maintaining, storing and disposing of records while protecting any personal information and ensuring complainant confidentiality • complaints handling data is a useful means of tracking compliance issues or risks. ASIC may require licensees to produce complaints data in certain circumstances, so data should be maintained in an accessible form • ASIC has indicated that the recording system should at least be able to identify the number of complaints which were resolved by the end of the next business day after the day on which the complaint was received • reports should be prepared for top management of the organisation, which should include the actions taken and decisions made and should be available for inspection by ASIC in certain circumstances, for example, during surveillance. Step 8 Continual improvement • the continual improvement of the complaints handling process and the quality of products and services should be an ongoing objective of each AFS licensee • this involves conducting a regular review of IDR procedures to identify areas for improvement. ASIC considers that the frequency of reviews may vary according to the size of the organisation and their complaints volume, but that these should be conducted at least every two (2) to three (3) years. They have also indicated that larger organisations may benefit from an independent review. ASIC consultation on lifting standards and transparency of complaints handling In March 2019, ASIC issued Consultation Paper 311 “Internal dispute resolution: Update to RG 165” (CP 311) which includes proposed updates to its Internal Dispute Resolution (IDR) standards. One recommendation is to update the guidance to reflect the requirements for effective complaint management in Australian Standard AS/NZS 10002:2014 (Guidelines for complaint management in organisations). The definition of a “complaint” has been amended from that provided in AS ISO 10002:2006 (now superseded) to: “[An expression] of dissatisfaction made to or about an organization, related to its products, services, staff or the handling of a complaint, where a response or resolution is explicitly or implicitly expected or legally required”. CP311 also proposes a more controversial amendment, being the maximum IDR response times. ASIC considers that the standard response time frames that firms must provide a final IDR response to a complainant (being 45 days or 90 days for superannuation and traditional trustee complaints) are too long and should be reduced to 30 days and 45 days respectively.

In addition to the updated standards, the draft RG 165 also includes a proposed framework for new mandatory IDR data reporting by financial firms to ASIC. ASIC released new Regulatory Guide 271: Internal dispute resolution in July 2020 and is effective from 5 October 2021. For complaints received by financial firms before that date, Regulatory Guide 165: Licensing: Internal and external dispute resolution applies. ASIC will withdraw RG 165 on 5 October 2022.

¶8-615 External dispute resolution Each Financial Services or Credit Licensee that provides advice to retail clients is required, as a condition of their licence, to be a member of an external dispute resolution (EDR) scheme that is approved by ASIC. Prior to 1 November 2018, there were two ASIC-approved EDR Schemes: the Financial Ombudsman Service and the Credit Ombudsman Service. All schemes were required to deal with claims worth up to $500,000, even though they were allowed to limit the maximum amount of compensation payable per claim to less than that amount, in accordance with their rules at that point. EDR Scheme rules barred a complaint involving more than the applicable compensation limit. EDR Schemes were only allowed to limit (cap) the maximum amount of compensation payable per claim to a minimum of $280,000 (or $150,000 if the claim related to an insurance broker) with the ability to opt for a higher figure in the rules of the scheme. Financial Ombudsman Service The Financial Ombudsman Service (FOS) was formed in 2008 from the amalgamation of five separate dispute resolution bodies for financial services. This independent umpire provided free, fair and accessible dispute resolution for consumers and some small businesses who were unable to resolve a dispute directly with their financial services provider. EDR processes can help to resolve disputes through negotiation or conciliation as an alternative to court proceedings and can make decisions which are binding on participating financial services providers. AFS licensees who were required to obtain a credit licence could utilise their FOS scheme at the time as the EDR scheme for their credit licence. The Credit and Investments Ombudsman Service The Credit and Investments Ombudsman Service (CIO) provided accessible, independent and fair dispute resolution services to consumers and financial service providers. Like FOS, CIO was an ASICapproved EDR body to which Financial Services or Credit licensees had to belong. CIO offered an impartial dispute resolution service as an alternative to legal proceedings for resolving complaints with participating financial service providers. The Superannuation Complaints Tribunal The Superannuation Complaints Tribunal (SCT) dealt with certain complaints about superannuation. FOS did not cover complaints that the SCT dealt with. Such complaints included: • most decisions of superannuation trustees • decisions of insurers in relation to insurance benefits provided under superannuation funds, and • the decisions and conduct of life companies as providers of immediate and deferred annuities. Australian Financial Complaints Authority From 1 November 2018, the AFCA deals with financial system complaints replacing the FOS, CIO and the SCT. AFCA has equivalent powers to the SCT when dealing with superannuation complaints and enhanced

reporting obligations to ASIC, APRA and the Commissioner of Taxation as relevant with respect to the nature of complaints with which it deals. It is, similarly, able to deal with complaints about financial firms including banks, credit providers, insurance companies and brokers, financial advisers, managed investment schemes and superannuation trustees. AFCA has significantly higher monetary and compensation limits for consumer ($500,000 compensation cap, with a claim cap of $1m) and small business credit complainants ($5m), as well as providing enhanced access to free dispute resolution for primary producers. ASIC will oversee the operation of AFCA and receive reports including about systemic issues and serious contraventions by financial firms. AFCA is funded by its members. All financial firms (broadly those that provide financial and credit services to consumers and small business) are required to hold membership of an external dispute resolution scheme ie required to be members of AFCA. AFCA members are required to: • take reasonable steps to cooperate with AFCA to resolve any complaint under the AFCA scheme • give reasonable assistance to AFCA and to identify, locate and provide documents and information to AFCA that are reasonably required for AFCA to resolve complaints, and • give effect to any determination made by AFCA in relation to the complaint. Where members do not satisfy the requirements, matters can be referred to ASIC and members will be subject to the existing penalty regime. Treasury Laws Amendment (AFCA Cooperation) Regulations 2019. Remediation and advice review programs ASIC has released Regulatory Guide Client review and remediation conducted by advice licensees (RG 256) which builds on ASIC’s recent experience overseeing review and remediation programs, as well as existing ASIC guidance on dispute resolution in RG 165 Licensing: Internal and external dispute resolution. RG 256 sets out ASIC’s guidance on client review and remediation that: • is conducted by Australian financial services licensees who provide personal advice to retail clients (advice licensees); and • seeks to remediate clients who have suffered loss or detriment as a result of misconduct or other compliance failure by an advice licensee (or its representatives) in giving personal advice. Review and remediation, which may be large or small scale, generally aims to place affected clients in the position they would have been in if the misconduct or other compliance failure had not occurred: see RG 256.5–RG 256.6 and RG 256.13–RG 256.20. Key considerations for licensees include: • when to initiate the process of review and remediation (Section B) • the scope of review and remediation (Section C) • designing and implementing a comprehensive and effective process for review and remediation (Section D) • communicating effectively with clients (Section E), and • ensuring access to external review (Section F).

INVESTMENT The big picture

¶9-000

Key concepts relating to investment

¶9-020

Three pools of wealth

¶9-050

Investment asset classes

¶9-070

Diversification of investments

¶9-080

Cash and fixed interest Cash and fixed interest

¶9-110

Short-term money markets

¶9-130

Term deposits

¶9-140

Debentures

¶9-150

Bonds

¶9-160

The yield curve

¶9-170

Pricing differentials

¶9-180

International fixed interest

¶9-200

Equities Domestic equities

¶9-250

Market indices

¶9-260

Industry sectors and subgroups

¶9-265

Returns on equities

¶9-275

International equities

¶9-300

Property Residential property

¶9-310

Listed property trusts

¶9-312

Property returns and valuation

¶9-314

Direct property versus shares

¶9-316

Specialist assets Other types of investments

¶9-320

Infrastructure

¶9-325

Commodities

¶9-330

Derivatives

¶9-335

Warrants

¶9-340

Hedge funds

¶9-345

Hybrid securities

¶9-350

Private equity

¶9-355

Tax-effective investments

¶9-360

Collectables

¶9-365

Socially responsible investments (SRIs)

¶9-370

Cryptocurrency

¶9-375

Asset allocation

¶9-380

Investment management styles

¶9-400

Investment products Direct investing

¶9-420

Master trusts and wrap accounts

¶9-430

Unit trusts

¶9-450

Cash management accounts

¶9-470

Australian fixed interest trusts

¶9-480

Mortgage offset

¶9-490

Mortgage trusts

¶9-495

Australian property trusts

¶9-500

Australian equity trusts

¶9-520

International trusts

¶9-530

Listed investment companies and exchange traded funds ¶9-535 Diversified trusts

¶9-540

Investment bonds

¶9-600

Managed accounts

¶9-610

Performance measurement Performance measurement

¶9-700

Industry benchmarks for investments

¶9-710

Risk assessment

¶9-720

Managed funds research

¶9-800

Portfolio reviews

¶9-815

¶9-000 Investment

The big picture As part of the financial planning advice process, investment planning is a key subject area. Before making investment choices, a financial planner must consider the following: • What are the client’s needs and goals — both now and into the future? • What is the client’s tolerance to risk, ie volatility in investment value? The initial answers to these questions may contradict each other. It is the planner’s job to inform the client what is possible given the parameters that have been set, allowing the client to make an

informed decision. Once responses are determined that are in alignment, an appropriate portfolio can be built to accomplish the desired level of return with the least necessary amount of risk, relative to the underlying nature of the investment. This chapter looks at a proper assessment of goals and risk. Each of the main assets is discussed in some detail, as well as the main investment vehicles that can be utilised. Measures of investment performance are also examined.

¶9-020 Key concepts relating to investment Simple interest Simple interest refers to a single interest payment. If you lend $1,000 at 4% interest per year, you will get back $1,040 at the end of the year. A payment may be made annually, but for whatever period of time the rate of payment remains the same. Period of time

Payment

End year 1

$40

End year 2

$40

Final year (maturity)

$40 (plus original $1,000)

The formula for calculating the amount of interest earned is as follows: I=

P × R × T, where:

I=

the interest earned over T periods

P=

the principal or amount of money

R=

the interest rate being paid (decimal)

T=

the number of periods.

Simple interest assumes the money is paid out and is not reinvested. The future value of a simple interest investment is expressed as: FV = P (1 + RT), where:

FV = the future value Compound interest Compound interest calculations assume all income earned is reinvested. For each succeeding period the interest rate is calculated, the principal figure has grown by the amount of interest earned in the previous period. To calculate the value of investments where compound interest (or reinvestment of income) is paid, the simple interest formula above is modified to reflect the “interest on interest” factor: FV = PV (1 + R)T, where:

FV = the future value PV = the present value

R = the interest rate per period expressed as a decimal T = the number of periods. Yield Yield is the amount received from an investment expressed as a percentage of the purchase price. Yield calculations are used to compare the return of various investments. An example of yield is the rent received for a residential investment property. If the purchase price of the property was $500,000 and the annual rent received is $26,000 ($500 × 52 weeks), the yield would be calculated as: (500 × 52) × 100 = 5.20%     500,000     The rental yield is therefore 5.20%. This is a basic example of yield and does not include expenses which should be taken into account. Please note that there are different calculations of yield when investing such as current yield, yield to maturity and yield to call; however, these are beyond the scope of this chapter. Dividend A dividend is the term given to the income distributed by listed Australian and international shares. It represents that part of the relevant company’s earnings which is distributed to its shareholders. See ¶9275. A word of caution Many investors fail to properly compare the value of an income stream from shares with other assets by simply using the headline income or yield figure. For example, a listed Australian company may be currently yielding 4% income (through dividends) based on its current share price. It is a mistake for income conscious investors to simply compare this 4% yield with, say, a cash investment yielding 4%, and conclude that the return on these two investments is comparable. There are two differences. First of all the company can grow and as it does it may increase the dividends it pays to its shareholders. Therefore, the income stream to the shareholder grows, increasing the yield of the original investment. An investor should be aware that, in rare instances a company may be forced to cut or forgo paying dividends. Secondly, tax. The income from the company may carry some tax advantages through imputation credits. It is necessary to “gross-up” the company’s dividend to properly value its income on a pre-tax basis. Another point to consider when assessing dividend yield for a company is that it may have a high yield; however, this may be the result of a falling share price that could be a sign of underlying issues with the company. Investment timing and dollar cost averaging Investment timing is primarily concerned with three issues: • When is the best time to buy an asset? • For how long should the asset be held? • When is the best time to sell an asset? Market-timers or “technical” investors believe they can select the right time to make investments — buying when asset prices are low and selling when they are high. Other investors adopt a long-term approach, often referred to as “buy and hold” approach to investing because they believe it is more important to be in the market than to take the chance and get their market timing wrong. This table demonstrates how dollar cost averaging works when $1,000 per month is invested into an asset with price volatility.

Month

Invest ($)

Price ($)

1

1,000

1.18

847.4576

2

1,000

1.20

833.3333

3

1,000

1.23

813.0081

4

1,000

1.20

833.3333

5

1,000

1.25

800.0000

6

1,000

1.27

787.4016

7

1,000

1.24

806.4516

8

1,000

1.28

781.2500

9

1,000

1.29

775.1938

10

1,000

1.30

769.2308

Total

10,000

Average price per unit

Units

8,046.6602 1.24

An investor who waits to save up the $10,000 to invest in month 10, buys 7,692.3077 units ($10,000 divided by the $1.30 price). However, with the dollar cost averaging approach the investor buys an extra 354.3525 units. Given a unit of $1.30 per unit, the investor is $460 better off. A “dollar cost averaging” strategy, possibly implemented via a savings plan, is a popular way of managing risk associated with market fluctuations. This strategy involves systematically investing a fixed dollar amount at regular intervals. By making purchases during both falling and rising market periods the investor aims to achieve the average price over the period. While the investor will not receive the lowest possible price, it avoids the temptation of buying too much when prices are high (believing they will go higher) or failing to buy when prices are relatively lower.

¶9-050 Three pools of wealth In order to be financially independent, you need three pools of wealth — peace of mind, lifestyle and retirement. (1) Peace of mind wealth — these are the funds required for day-to-day living and emergencies, as well as short-term goals (perhaps up to one year ahead). (2) Lifestyle wealth — this is for medium to long-term goals prior to retirement. It could include funds for upgrading a house, a big holiday or a new car. (3) Retirement wealth — these are the funds required to fund life after working. The great bulk of this pool would normally be in superannuation. By dividing wealth up this way, you are better able to choose appropriate investment products catered to meet these requirements. For example, tying up wealth entirely in cash-based investments may neglect retirement wealth requirements which often require a much higher level of return to meet desired retirement income levels. Alternatively, investing one’s wealth entirely in property may neglect the liquidity requirements of peace of mind wealth. Defining the requirements of these three pools of wealth is the starting point of the investment process. Peace of mind wealth The starting point for calculating the value of this pool is the drawing up of a budget. This determines the amount required for day-to-day living expenses.

The next step is adding in cash requirements for any short-term goals — it might be a family holiday, for example. The final step is adding an appropriate amount set aside for a cash reserve. This is to cover any emergency expenditure. The amount here could vary from person to person. As little as $1,000 may be enough for a single person. More may be required for a larger family. As these funds need to be readily accessible either to meet living expenses or for an emergency, the suite of appropriate vehicles to store these funds are restricted to cash-based products. Lifestyle wealth The difficulty in assessing values for this pool of wealth is that a person’s pre-retirement goals can change so much, governed by a range of factors such as marriage, children, divorce, changing jobs or simply just changing one’s mind. While appropriate investment products should be chosen to match the time frame of these goals, it should be kept in mind that priorities do change and that these time frames can subsequently change also. Therefore, there is still a need for the products chosen to have reasonable liquidity. Certainly the suite of investment products is much larger than is the case for peace of mind wealth. This will depend on the time frame but bonds, property, shares and others become possibilities. Retirement wealth The ideal level of retirement wealth is determined by the desired income level after one has stopped working and retired. The longer the length of time is until these funds are required, the more difficult this can be to determine. It is easy to say when you are 25 years old that you want to retire at 50 years of age on $100,000 a year, but that will not always be possible. People are also often surprised by their income requirements when retirement actually starts, since they will usually vary quite considerably from those during working life. When there is no mortgage and the kids have left home, your required level of income will often be considerably reduced. The earlier you address this pool, the more control you will have over retirement income. Without longterm planning, options will close off as retirement approaches. Retirees may have to settle for a lower level of income or even be forced to work longer to ensure this pool lasts the remainder of their lifetime. With life expectancies continuing to increase, the government has been exploring opportunities for product development associated with managing longevity risk through risk pooling. Typically this pool of wealth relies heavily on investments that offer higher long-term returns. One’s retirement can last 20 or 30 years or longer and so will require a considerable level of assets. Assets such as shares and property which can generate capital growth are usually required to maximise the life of this pool, not only by people saving for a future retirement, but also by those already in retirement due to the increase in life expectancy.

¶9-070 Investment asset classes Investment assets can broadly be split into two groups: growth and defensive. Growth assets, as the name suggests, have the ability to grow in capital value. That is, the underlying market value of the asset can grow over time, increasing the capital value. Equities and property are the main types of growth assets. Equity growth comes from companies reinvesting part of their earnings to become bigger companies. Take Australian supermarket giant Woolworths, for example. Its profits are not entirely distributed to its owners (shareholders). Part of the profits are distributed through dividends and part are reinvested back into the company to buy more supermarkets or upgrade its existing ones, or do any number of things to further increase profits and so distribute more to shareholders via dividends in the long run. In the case of property, growth comes from increased demand for its use via rent. A residential property might increase in value because it is in a prime location, is close to amenities or has great views. If the demand for such properties increases, renters become willing to pay higher rents. The ability to generate

higher income will increase its overall value. The trade-off for this benefit is more risk. This manifests itself in higher volatility, meaning the price of the asset can have more extreme moves. Equities can drop in value as can property prices. Indeed, bad investments in these sectors may never recover lost value. Sensible, well-researched investments, however, have the potential to recover and provide investors with long-term returns much higher than that available through a so-called risk-free investment such as cash. Defensive assets trade-off the higher potential returns from growth assets for greater security. These include fixed interest (both domestic and international) and cash investments. The following table illustrates the historical returns of each of the major asset classes. 1 January 2000 to 31 December 2019 Australian shares

International shares

Global property

Australian fixed interest

International fixed interest

Cash

Mean historical return

9.7%

5.9%

10.9%

6.2%

7.2%

4.3%

Best annual return

37.6%

48.9%

40.1%

15.0%

11.7%

7.6%

Worst annual return

−38.9%

−27.1%

−48.1%

1.7%

1.7%

1.5%

4.85

3.19

6.15

63

252

0

Incidence of a negative return every X years

Source: Morningstar, Count Financial It should be pointed out that the capital value of fixed interest assets can change but, due to its nature, is not capable of consistently generating the higher long-term returns of growth assets. The difference in the performance of growth assets as against their defensive counterparts is clearly demonstrated by the following chart showing the value of $10,000 invested in each of the main asset classes as measured by an appropriate index.

Source: Vanguard Business cycles During the course of a business cycle the relative value of various asset classes changes. For example, according to the business cycle theory, the best time to increase exposure to equities is when interest

rates are low during the final stages of a recession. Equities generally perform well until several consecutive interest rate increases occur as the Central Bank attempts to control inflation. Opportunity cost This is the cost borne due to not choosing one alternative in favour of another. Every investment decision entails an opportunity cost because when one investment opportunity is accepted the opportunity to invest in an alternative is forgone. When making investment recommendations and reviewing portfolios, financial planners must continually assess the opportunity cost of any decision. For example, ultra conservative clients eventually incur the opportunity cost of higher returns achieved by a growth portfolio. Cash Cash assets are seen as holding two advantages: liquidity and security. The first is certainly true — everyone needs some portion of their funds in cash to meet day-to-day living expenses and to access immediately in case of emergency. This makes it ideal for our first pool of wealth, peace of mind. The second, however, is one of the great myths that many investors have trouble coming to terms with. While it is true that in nominal terms a cash asset rarely incur capital losses (eg from a bank default), in real terms cash can often provide the lowest long-term return out of the range of investments available. This is because of inflation. Inflation Inflation erodes the value of money. In an inflationary environment, a dollar in one’s pocket is technically falling in value with each passing moment. You could buy a lot more with a dollar 30 years ago than you can today.

Source: RBA The graph above shows the real value of $100 since 1970. It illustrates the fact that $100 in December 2019 could only buy approximately 1/15th of what it could in 1970. Therefore, unless one’s investment is at least keeping pace with inflation (a common measure of inflation is the Consumer Price Index), you’re actually falling behind. The problem with most cash investments is that they struggle to keep pace with inflation, even in the current low inflationary environment. This makes their risk-free status highly questionable. Another way of looking at the risks of investing in cash is when comparing the compounded return on cash (measured by one-year term deposits) against the compounded return of Australian share dividends (excluding benefits from franking credits). Income on $10,000 investment

Source: Bloomberg, RBA The graph illustrates the growing income stream provided by investing in listed companies. Cash, by contrast, does not provide a growing income stream, indicating that the purchasing power of the investment is eroding.

Note The anomalies shown in the graph in the dividend return in the late 1980s were caused by the introduction of dividend imputation, which ended the double taxation of company profits.

Risk assessment While understanding the client’s financial objectives is an important element in the financial planning advice process, risk assessment is also an important aspect. Risk assessment involves determining the appropriate mix of growth and defensive assets. Financial planners must consider two factors to make an informed risk assessment: (1) The most important factor is the expected rates of return to be assigned to the asset classes discussed earlier. Once these values are determined, we can decide what kind of investments to make and so what level of risk will need to be undertaken to achieve these values. (2) The second factor is the level of volatility the person is willing to tolerate in their investment value. Step 1 must be undertaken first. It is the role of a financial planner to ensure their client undertakes the minimum level of risk required in order to achieve their goal. Case study 1 David has a lifestyle goal of upgrading his car in five years’ time. Alan, his financial planner, calculates that given the funds set aside for this, it can be achieved within the required time frame with a 1% pa return required after considering inflation. As cash rates are close to 2%, Alan concludes that a cash investment should ensure David’s goal is realised in the required time frame. There is therefore no need for David to invest in a more volatile asset than cash in the hope of generating a higher long-term return on his investment.

Step 2 is still important. If the investor has limits to the degree of volatility they can tolerate with their funds, it can restrict the type of investments that can be used and consequently the level of return that can be realised. Case study 2 Take case study 1 again. Suppose the adviser, Alan, determines that the required level of return for David to buy his chosen car is 6% pa. Alan determines that an investment which carries the possibility of some short-term volatility may be necessary for this level of return to be attained.

However, David has made it clear that he will only invest in an asset that has no chance of falling in value. Alan does not believe a cash investment will see David’s goal realised. In this case we have Step 2 overriding Step 1. David’s ability to cope with volatility has overridden the type of investment Alan believes is necessary to see this goal realised. In this case, one of two things must occur: (1) David must re-evaluate his goal — either the cost or the time frame. (2) David must re-evaluate his ability to cope with volatility to see his goal realised.

Assessing these factors is known as risk profiling. Good financial planners use a formalised process to undertake risk profiling such as a questionnaire followed by a discussion of the answers. Relevant questions to determine the desired values of each pool of wealth include the following: • What are your investment objectives and required time frames? • What is your primary source of income and to what extent do you rely on it? Relevant questions to determine one’s attitude to volatility include: • What type of investments have you held in the past, or what type do you currently hold? • What would you do if your portfolio fell by 20% in one year? The answers to these types of questions provide the financial planner with information on what the client wants or needs and what type of investments the client would feel comfortable using in order to achieve their objective.

¶9-080 Diversification of investments Fortunately, investing is not an either/or choice; that is, investors do not have to make the decision to invest entirely in growth assets or defensive assets. For most people, the ideal point will be somewhere in between these two extremes. Modern portfolio theory has shown that investing in a range of assets can effectively reduce risk (volatility) for a desired level of return. This is based on the assumption that different asset classes perform differently as the economy progresses through the business cycle. The following table shows the performance of each of the major asset classes over the last 10 years. Annual percentage return of major asset classes Calendar year to

Aust. shares

Int’l shares

Global prop. (GREIT)

Aust. fixed int.

Int’l fixed int.

31 Dec 10

1.9%

−1.5%

19.6%

6.0%

9.3%

31 Dec 11

−11.0%

−4.8%

−3.6%

11.4%

10.5%

31 Dec 12

19.7%

14.9%

32.0%

7.7%

9.7%

31 Dec 13

19.7%

48.9%

9.9%

2.0%

2.3%

31 Dec 14

5.3%

15.6%

23.3%

9.8%

10.4%

31 Dec 15

2.8%

12.4%

5.2%

2.6%

3.4%

31 Dec 16

11.8%

8.6%

6.9%

2.9%

5.2%

31 Dec 17

11.9%

14.0%

9.2%

3.7%

3.7%

31 Dec 18

−3.1%

2.1%

−3.0%

4.5%

1.7%

31 Dec 19

23.8%

28.7%

22.3%

7.3%

7.2%

10 yr. Minimum

−11.0%

−4.8%

−3.6%

2.0%

1.7%

10 yr. Maximum

23.8%

48.9%

32.0%

11.4%

10.5%

5 yr. Avg.

9.4%

13.2%

8.1%

4.2%

4.2%

10 yr. Avg.

8.3%

13.9%

12.2%

5.8%

6.3%

Indices used

S&P/ASX 300 Total Return

MSCI FTSE EPRA/ Bloomberg Barclays World  NAREIT Developed Total Return (Hedged AUD)  AusBond Capital exComposite Global Australia Total Aggregate Return Total Return (Hedged AUD)

Source: Morningstar, Count Financial What can be seen from the table is that from year to year it is near impossible to predict the best performing asset class. Modern portfolio theory uses this to the investor’s advantage. A spread of assets can reduce the volatility inherent in all asset classes (particularly growth assets). Applied correctly, for a given level of return, a portfolio can be found that offers the minimum level of risk. For a given level of risk, a portfolio can be generated that offers the highest possible expected rate of return. A number of optimisation techniques exist to find these ideal portfolio mixes. The problem is that they either rely on historical return levels and volatility or forecasted levels. They will therefore not prove to be 100% accurate. However, there can be no doubt that diversifying into a number of different asset classes in a controlled manner can serve to provide an acceptable trade-off between risk and return. The following graph charts the potential risk and return outcome achievable by investing in a number of separate asset classes or a combination of these asset classes.

Source: Morningstar, Count Financial Limited This chart is used for illustrative purposes to show that diversification benefits can be obtained by combining different asset classes. By investing in multiple asset classes (as illustrated by the balanced point in the chart), an investor can achieve either a better return or risk outcome than by investing in individual asset classes. Core risk profiles Given the advantages of diversification, it is the job of the financial planner to find the ideal balance between the asset classes to reach their clients’ goals (pools of wealth) given their accepted level of risk. While each person is different with varying goals and ability to cope with risk, it is generally agreed it is possible to group the majority of investors into some core profiles.

These profiles specify the ideal division between growth and defensive assets to achieve the maximum level of return possible given their ability to cope with volatility. An example of what some of these profiles might look like is shown below: Investment profile Investment term Benchmark Net return objective Asset balance Growth v defensive Standard Risk Measure (Likely number of negative annual returns over a 20year period)

Conservative/Capital Moderate/Conservative stable balanced Balanced

Growth

High growth

3+ years

3–5 years

5+ years

7–10 years

7–10 years

CPI +  2.0% 

CPI +  2.5% 

CPI +  3.0% 

CPI +  4.0% 

CPI +  4.0% 

30/70%

50/50%

70/30%

85/15%

100/0%

Low to medium 3

Medium 4

Medium Medium 4 to high 5

High 6

Source: CareSuper Effective diversification can ensure long-term growth without the extreme volatility experienced by some specific asset classes. The following chart compares the performance of Australian shares, international shares and fixed interest against an index of “balanced” managed funds that invest in a range of asset classes (around 60%–70% in growth assets). The important point to note is the long-term balanced return without the volatility extremes of the two share indices.

Source: Morningstar, Count Financial, Vanguard

CASH AND FIXED INTEREST ¶9-110 Cash and fixed interest Fixed interest securities are debt instruments, whereby the investor lends money with the expectation of a

full return of capital and a payment of interest. They are usually defined by the: • length of the loan period • interest payment • type of issuer (and credit rating) • security which backs the debt. When a fixed interest security is issued, it usually has a set coupon payment. However, there are some debt instruments which offer a variable rate or a rate of return indexed to inflation. Generally, the longer the period and the less secure the lender, the higher the interest rate. In most cases, the issuer is not required to return the borrowed capital until maturity. Therefore, the investor must either hold the instrument to maturity or sell it to another investor on the open market. Since the coupon payment on the security is fixed, the price offered for the instrument varies in line with current market interest rates. In this way, bonds sold prior to maturity may provide the investor with either a capital gain or a capital loss. Australia has been in a period of falling interest rates. In this environment, bond investors may have experienced capital gains from portfolios if they had sold a security prior to maturity. However, returns will depend on the actual underlying securities. Cash and at call money “At call” means the investor can get their money back on demand. The only “at call” option is a cheque/savings account with a bank, building society or credit union. While cash in the bank is low risk, real (after inflation, but before tax) long-term annual returns are very low. After tax, real returns may even be negative. There is no capital growth, and all interest is taxed as income.

¶9-130 Short-term money markets The money or cash market is where large institutions and companies borrow and lend for periods as short as overnight. Transactions are usually in the millions of dollars. The types of instruments traded are bank bills, promissory notes, and certificates of deposit. Because investments in the money market are usually for a duration of less than a year, their pricing is treated as a simple interest calculation. Investors can gain access to the money markets through pooled investments which are discussed at ¶9470, or directly, as mentioned earlier.

¶9-140 Term deposits Term deposits are bank products where deposits are made for a fixed time period, commonly one to five years. As term deposits are a bank product, their investment risk is low. Interest is treated as income for taxation purposes. There is no growth of capital. Term deposits have an interest rate risk because the money is locked away for a period of time. When interest rates are rising, investors incur an opportunity cost. In addition, there is reinvestment risk because the investor cannot reinvest at the previous rate upon maturity of the term deposit if interest rates have fallen.

¶9-150 Debentures Debentures are corporate debt securities or corporate bonds. Most debentures are unsecured — that is, they are not backed by physical assets. Debentures are usually issued for terms of up to 10 years. Not all debentures are the same. Investors must rely on the financial strength of the company and the security that is offered.

Debenture holders face risks related to liquidity, credit rating and interest rate changes which may affect the capital value of the asset prior to maturity. Unsecured debentures also pose the risk that the underlying issuer could default on their interest payments or could go bankrupt prior to maturity, leaving an investor exposed to loss.

¶9-160 Bonds Bonds are debt securities and are issued with maturities starting from one year. The main features of bonds are outlined below. Face or maturity value: The amount to be repaid at maturity date. Coupon: The rate of interest as a percentage of the face value. The frequency of the coupon payments can vary. Maturity: Date when the face value and last interest payment is due for repayment. Yield to maturity: The rate of return on a bond, if held to maturity (assuming all coupon payments are reinvested and this compounded interest earns the same rate of return as the yield to maturity). There are two main issuers of bonds — governments and corporates. As the Australian market for corporate bonds is small, big companies often issue bonds in more active overseas markets although a recent development is the offering of Exchange Traded Bonds (XTBs) on the ASX which allows retail investors to buy units in a trust structure which invests in a single corporate bond. The main bond market, however, is for federal, state and semi-government instruments. When bonds are purchased at issue and held to maturity, there is no capital growth and the interest is treated as income for tax purposes. Where a bond is purchased on the market at a discount and sold at a higher price or redeemed at maturity, there is a capital gain. Conversely, if the bond is purchased at a premium to its face value and sold at a lower price or redeemed at maturity, there is capital loss.

¶9-170 The yield curve At any given point in time, the market will assign a price for a particular bond. The price the market is willing to pay for that bond at that time indicates the market’s future outlook for interest rates. There is an inverse relationship between bond prices and yields. If interest rates rise, the price of a bond will fall to the point where the return at maturity (comprising of interest and change in capital value) will yield the current market rate. If interest rates have fallen, the bond price rises until its yield is equal to the market rate. When yields are plotted for bonds with differing maturities, a yield curve forms. This yield curve is a picture of market participants’ interest rate expectations. The shape of the yield curve changes with market sentiment. A positive (or normal) yield curve is a rising yield curve reflecting lenders demanding more compensation for holding a bond with a longer maturity date compared to the shorter term bonds commanding relatively lower yields. This factor is sometimes

referred to as the Term Premium. An inverse (or negative) yield curve is the reverse, with bonds with a longer maturity paying a lower yield than shorter dated bonds. This typically occurs when the market expects a recession and lower interest rates in the future. Capital gains can be made by correctly projecting the movements along the yield curve. Likewise, incorrect analysis results in capital losses. Investors need to understand this as many assume bonds are capital secure investments. Example Corporate trader, Bonnie, wants to purchase a bond because she believes interest rates will fall. Corporate trader, Clyde, the holder of the bond, believes interest rates will rise and therefore wants to sell the bond now before it loses value. Unless the bond market remains flat, one of them will make a capital gain and one a capital loss. If interest rates fall, Bonnie makes a profit as the bond price rises. The bond price rises because its coupon rate is more attractive than at the time Bonnie purchased the bond. If interest rates rise instead, Clyde was better off selling the bond and Bonnie faces a loss. Using a face value of $100 and a coupon rate of 8% with 10 years left until maturity, what happens if interest rates drop to 7% or rise to 9%? The bond is worth approximately $107.106 per $100 of face value if interest rates drop to 7%. It is worth only $93.496 per $100 if interest rates rise to 9%.

¶9-180 Pricing differentials The price of bonds can be affected by several factors besides interest rates. First, there is the creditworthiness of the issuer. The higher the credit rating, all things equal, the lower the borrower’s relative interest rate. In effect, the lender takes a lower interest rate in return for the higher security of payment of principal and income. The supply of bonds is another factor. When supply is limited, the buyers bid up the prices of the existing bond and thereby lower the yield to maturity. Most investors obtain fixed interest exposure through pooled investment structures (¶9-450), noting that exchange-traded Australian Government Bonds (AGBs) are now available and trade alongside all ASX-

quoted securities. The Australian Stock Exchange (ASX) also offers retail trading in the corporate bond market and some exchange traded fund (ETF) providers offer bond index products that trade on the ASX. Financial planners and their clients can build a portfolio including both direct equities and fixed interest. As direct investment can be less expensive due to the absence of manager fees, investors gain an additional advantage. An active corporate bond market assists smaller companies to manage their funding requirements better, by lowering borrowing costs. This limits the need to look overseas for funding, which involves currency risks. Financial intermediaries such as insurance companies benefit through a larger selection of investments to back their long-term liabilities, such as annuities.

¶9-200 International fixed interest The investment opportunities in international fixed interest are much broader than in the domestic sector. As well as a range of government-backed securities with varying credit ratings, the corporate bond market is considerably more active. In addition to the risks associated with investing in domestic fixed interest, international fixed interest exposes the investor to currency risk and sovereign risk. Sovereign risk is the risk that the government may fail or be replaced by one which either defaults on the debt or changes the economic management. This increases the risk of holding international fixed interest assets. Currency risk is the risk that an investment may fall in value due to the foreign currency depreciating relative to the Australian dollar. For instance, if an international bond was denominated in US dollars and the Australian dollar appreciated against the United States, the value of the bond to an Australian investor falls. In the Australian market, nearly all international fixed interest managed funds are fully hedged and therefore currency risk is not an issue.

EQUITIES ¶9-250 Domestic equities Equities or shares offer investors the opportunity to participate in the growth and profitability of companies. In doing so, investors also take on the risks associated with owning a business. While the Australian share market is dominated by the large institutions and, significantly, large overseas institutions, an increasing number of smaller investors are attracted to the market. There are many reasons for this, including: • an increase in market value over a long period of time • greater press coverage on the market and share ownership • a more active share broking and financial planning community • self managed superannuation funds (SMSFs), which are providing investors with the structures and money to invest in the share market • the dividend imputation system, which is attractive for Australian investors • administration systems, including master trusts and wrap accounts, which are making shareholding easier as they provide custodial and reporting services.

¶9-260 Market indices

While a stock’s performance ultimately depends on a company’s fundamentals, the performance of the stock market can be responsible for a large portion of a stock’s performance in the short to medium term. An analogy of a rising and falling tide is often used to illustrate this. A rising tide will lift all boats except the ones that have serious problems. A falling tide, however, will take most boats with it except the exceptionally strong ones. Major market indices The huge growth of the funds management industry since the 1980s has greatly increased international capital flows and is thus partly responsible for the growing interrelationships among global financial markets. This means financial planners must monitor Australian market indices and key overseas indices. All Ordinaries The All Ordinaries is a statistical measurement of around 500 companies listed on the ASX weighted according to capitalisation size and commenced on 1 January 1980 at 500 points. The All Ordinaries Index does not include dividends paid by companies. The All Ordinaries Accumulation Index includes dividends and is therefore a better measure of total return. Standard & Poors has been responsible for the calculation of the All Ordinaries and several other market indices since April 2000. The core indices are: • S&P/ASX20 • S&P/ASX50 • S&P/ASX100 • S&P/ASX200 • S&P/ASX300 • S&P/ASX Small Ordinaries index. Dow Jones Industrial Average The Dow Jones Industrial Average (DJIA), also called the Dow, tracks the performance of 30 blue chip US companies. The Dow is a price weighted index because a $1 movement in the price of a $100 stock counts equally with a $1 movement in the price of a $20 stock. Therefore, unlike most quoted indices, it is not a market capitalisation weighted index. The Dow originated in 1896, when journalist Charles Henry Dow first developed a method for tabulating an index that could be used to judge general stock market health. In 1928 the Dow grew from 12 to 30 stocks where it has been ever since. S&P 500 The S&P 500 is a broader measure of the US share market, which makes it a more accurate barometer of stock market activity. This index is weighted according to market capitalisation whereby the price of each stock is multiplied by the total number of shares outstanding. Most professional investors use the S&P 500 as the benchmark against which to measure a money manager’s performance. Nasdaq This index tracks the stocks quoted on the National Association of Securities Dealers Automated Quotation System (Nasdaq) stock market. The Nasdaq index began trading on 8 February 1971 and measures the performance of more than 3,000 companies with many companies belonging to the technology sector.

¶9-265 Industry sectors and subgroups Industry sectors are made up of groups of stocks belonging to certain industry groups, such as media, transport, resources and energy.

S&P classifies stocks into 10 economic sectors according to the Global Industry Classification Standard (GICS), which is a set of global industry definitions that uniformly classify companies according to the type of business operation they perform. GICS is designed to facilitate sector analysis and sector investment on a global basis. The Australian market is dominated by the financial sector, specifically, this sector makes up approximately 45% of the S&P/ASX 200 Index. Monitoring of the index requires care as the performance of these stocks will influence the size and direction of index movements quite significantly.

¶9-275 Returns on equities Income While some shares do not pay dividends, most Australian shares make two dividend payments per year. Companies must decide how much of the profits are reinvested in the company and how much is distributed to shareholders. As most shareholders expect to receive two half-yearly payments, a nonpayment is often seen as a sign of company weakness. The historical market average dividend yield for listed companies ranges between 3% and 5% pa and is expressed as cents per share. Example An investor with 10,000 shares who earns a dividend of four cents per share receives an annual payment of $400. The dividend yield is the dividend/share price therefore if the share is worth $1, the dividend yield is 4%. If the share is worth $4.00 per share, the yield is 1%.

Dividend imputation Dividends are paid out of after-tax company profits. The dividend imputation system allows for the final tax rate applied to company profits to be that of the investors’ marginal tax rate. The taxation treatment of franked dividends is discussed at ¶1-405. The dividend imputation system and the taxation of companies is discussed in greater detail at ¶1-400. Growth Generally, returns from shares come partly in the form of dividends and partly in the form of capital growth noting that the capital growth component varies dramatically among different stocks. Capital growth is also discussed at ¶15-010. The taxation treatment of capital gains is discussed at ¶2100.

¶9-300 International equities The Australian share market is in the top 15 largest markets in the world. However, it represents less than 2% of the world share markets by market capitalisation. Despite this, most Australian investors have limited exposure to overseas markets. One of the reasons is that overseas investing is perceived to be difficult. While from a transaction perspective, overseas investing can be just as easy as domestic share investing, there are additional factors investors must be aware of. International equities provide the same corporate ownership aspects as domestic shares, with the advantage of additional diversification benefits. Furthermore, overseas markets offer investment opportunities not available in the Australian market. However, in addition to the inherent volatility of the global share markets, investors must also bear the risk of exchange rate fluctuations. Transaction costs associated with direct investments in overseas share markets are typically higher than for the domestic market. Average long-term real returns are between 6% and 9%. The long-term real returns for the riskier emerging markets (eg BRICS — Brazil, Russia, India, China, South Africa) can be higher, although the risks of investing in emerging markets are also higher. Like all investment decisions, the question of whether or not to invest in overseas equities depends on the

relative outlook of overseas equity markets compared with the Australian equity market. For example, before the technology correction in April 2000, Nasdaq listed stocks (¶9-260) seemingly offered better investment opportunities than Australian technology stocks. However, for the next few years after that there was little need to search for investment opportunities among US stocks as the various US stock exchanges were either flat or trending lower. Hence, overseas investing entails a significantly greater research and analysis burden as investors must first identify the best performing international share markets. Alternatively, they must regularly monitor their chosen overseas market sectors to identify investment opportunities that are unavailable or represent better value than in Australia. This takes much time, effort and skill. For these reasons most investors prefer to gain exposure and an appropriate level of diversification to international equities via managed funds. Foreign investment fund taxation The Foreign Investment Fund (FIF) legislation was introduced to stop investors from placing investments offshore, automatically reinvesting any income/distributions without reporting the income as part of their annual tax return. Broadly, FIF taxation involved assessing total returns of foreign investment funds (whether income or unrealised capital growth) in each income year. The FIF rules were repealed with effect from the 2010/11 income year onwards. The FIF measures were replaced by a more specific anti-roll-up fund provision called the Foreign Accumulation Fund (FAF) rule. This is directed at the most abusive deferral cases, such as investments by Australian residents in accumulation funds located in low tax jurisdictions.

Note As the taxation of international assets is complex, financial planners who include international assets as part of a gearing strategy should consider consulting a tax technical specialist about the tax treatment of specific recommendations if necessary (see ¶11-230).

PROPERTY ¶9-310 Residential property For many Australians, property is their first and biggest investment. It is not uncommon for people to move several times in their lifetime due to changes in personal circumstances. Once the mortgage is paid off or even before, a popular investment strategy for many people is to purchase an income-producing property, which is often negatively geared. The popularity of negatively gearing an investment property, as opposed to shares, has more to do with the comfort level most people have with property as an investment rather than this being the best investment option. For many investors who buy a second property, this choice translates into a 100% property asset allocation. Disadvantages of such an overexposure to property include the items listed below: • The illiquid nature of property is a particular disadvantage to retirees who may need the flexibility to progressively draw down capital over the course of their retirement. • The high maintenance costs of property often detract from long-term returns. • Property transaction costs are much higher than typical transaction costs for more liquid assets, such as equities. • Property location is an important factor. • Property investors must bear the risk that the geographical location of the property becomes unattractive due to demographic or other unforeseen changes.

• Property investors must also bear the risk that the property may not be rented 100% of the time, and hence it will not be producing income at these times.

¶9-312 Listed property trusts As the average long-term returns for commercial property can be higher than for residential property, many investors seek exposure to this sector via a listed property trust. The first listed property trust to be listed on the Australian share market was GPT in 1971. Since this time the market has seen a number of changes, with the most recent notable change being the consolidation of the sector and the emergence of the stapled security. Stapled securities give investors exposure to funds management and/or property development companies as well as a real estate portfolio. The other change that has happened in recent times is the emergence of the global listed property trust market. Australia is one of the more developed global markets and local listed property trusts have taken advantage of the large global market and have been increasingly adding international assets to their portfolios. Benefits of investing in listed property trusts Listed property trusts provide: • diversified exposure to a professionally managed portfolio of real estate • dividend yield payments that are higher relative to stocks • potential for capital appreciation • liquidity in an illiquid asset class. Risks of investing in listed property trusts The risks of investing in listed property trusts are similar to investing in either direct property assets or stocks and include: • changes in the value of the underlying properties. When property values fall, unit prices decline • changes in dividend payments. Dividend payments depend on the general financial conditions of the property trust • vacancy rates may increase during economic downturns and put downward pressure on the value and income of property trusts • property trusts with low market capitalisations are often illiquid • rising interest rates are generally bearish for property trusts. When interest rates rise, investors demand higher yields, which puts downward pressure on market prices. Rising interest rates also increase the cost of financing, which decreases the value of the underlying property investment (ie gearing level itself is a risk factor) • the performance of listed property trusts also depends on the type of property and the geographical location. The economic cycle for different types of property varies with some geographical locations demanding higher prices over time and others falling out of favour. As the risks vary greatly among different types of property, diversification across a mixed portfolio of properties is the best defensive strategy. Investment in listed property trusts may also offer investors some tax advantages through tax-free and tax-deferred income components.

¶9-314 Property returns and valuation

Property returns are comprised of capital growth and rental income. As is the case with fixed interest securities (¶9-110), there is a relationship between the value of the property and its rental income. Specifically, the value of the property is a function of the level, certainty and continuation of the income stream and underlying value of the property. For example, let us assume that a large complex is valued at $20m and has two rental occupants. If one of the rental occupants gives notice that it will not renew its lease, the property’s value may be adversely affected. The property’s price will drop to the extent that: • there will be a gap in rental income payments • expenditure is required to get the rental area refurbished to re-lease • there will be a delay in getting new tenants • lease payments may need to be reduced to entice a new tenant into entering a new lease • other properties in the area are having similar problems • there is an over-supply of similar properties in the area • the property market is weakening • economic conditions are deteriorating. These concerns need to be considered in analysing the three ways in which property is valued — capitalisation of yield, direct comparison and discounted cash flow. Capitalisation of yield: This refers to the application of an established capitalisation rate to the estimated net annual income of the property. Example If the capitalisation rate for a particular type of property is 4.5% and the net rental income each year is $250,000, the property is valued at $5.5m. If the capitalisation rate increases, the value of the property decreases, much like the value of a bond. If the capitalisation rate increases to 6.6%, the value of the building decreases to $3.8m.

Direct comparison: Sometimes a direct comparison is made with recent sales of similar properties. This is often problematic because no two properties are the same and the reasons for buying or selling a property are usually different. Discounted cash flow: Similar to the pricing of an annuity, the value of the future income stream is discounted to today’s dollars to determine the current intrinsic value of that asset. Property values also change with the business and interest rate cycle. When interest rates are low, companies generally expand and thus require more space. Low interest rates also tend to keep a lid on rental increases leaving consumers with more money to spend and increasing their borrowing capacity. The converse is true in times of high interest rates. The higher the yield on a property, the higher the ownership risk. Different property sectors, such as commercial/central business district (CBD), inner city, fringe, industrial, retail, tourism and rural have unique return attributes, risk profiles and economic cycle behaviours.

¶9-316 Direct property versus shares Many Australians consider property ownership to be the best form of investment. Property’s popularity has much to do with human nature. It is human nature to be drawn to what we believe we know best and understand. The following are some of the factors a financial planner must assess when advising clients who already own a property as an investment or are considering buying one.

(1) Asset allocation The asset allocation should meet the client’s risk profile and long-term investment objectives. Typical asset allocations may allocate between 10% and 20% to property assets. Therefore, for a maximum 20% allocation, a client with investable funds of $750,000 should invest no more than $150,000 in property. (2) Diversification Diversification assists in managing asset specific risk. Owning one property misses the opportunity of gaining a diversification benefit through different types of property and geographical location. Ideally, property should be diversified into: • commercial • industrial • retail. Property should also be diversified geographically: • CBD vs fringe • Australia vs international • specific location. (3) Liquidity Shares can be liquidated in two days at minimal cost. However, property can take anywhere from a few weeks to months to sell. The costs of selling a property and buying a new one are substantial. (4) Divisibility A property must be sold in its entirety. A share portfolio can be sold in discrete bundles depending on how much cash is required. (5) Volatility of assets A common misconception is that property prices hardly fluctuate. This is a myth created by the fact that property prices are not monitored and quoted on a regular daily basis as shares are. Like all investment markets, property markets can also crash. During the property crash in the early 1990s, some prime properties lost half their value over several months and property trusts were unable to meet redemption requests. (6) Rental income Rental income from residential property is notoriously low when compared with other investments, such as high-yielding shares and fixed interest securities. Furthermore, it is not uncommon for rental income to remain flat for many years. Property investors must also bear the risk of not being able to immediately replace a tenant who has terminated a lease. For these reasons, clients who are approaching retirement must be particularly careful not to overexpose themselves to residential property. Financial planners must point out to clients that at retirement their entire focus will dramatically shift from one of capital accumulation to income generation and liquidity. To meet a client’s income needs, the best alternative is often to sell down residential property and to shift assets into more liquid and higher yielding investments. Due to the high transaction costs of property, a preferred alternative is to avoid overexposure to residential property in the first place.

SPECIALIST ASSETS ¶9-320 Other types of investments Apart from the standard asset classes, there are various other types of investments that financial planners

may recommend to clients. Some of these investments are directly available to personal investors while others are only available to large institutions or through pooled structures. Many financial planners are unwilling to acquire the necessary expertise required to make recommendations on specialist assets.

¶9-325 Infrastructure Infrastructure projects are usually developed by the government, sometimes in conjunction with private enterprise. They are large projects which shape the country, such as hydro-electric schemes, railways, airports, roads and hospitals. Over the last few years, a trend to raise capital for infrastructure projects via the stock market has emerged. Examples are the M5 Motorway in Sydney and power generation projects. In the past, infrastructure funding was solely the domain of large institutions. However, by corporatising and listing infrastructure projects on the stock market they are made available to personal investors. Exposure to infrastructure projects can also be gained through Australian or international pooled funds.

¶9-330 Commodities Commodities are real assets and include industrial and precious metals, energy, livestock and other agriculture produce. Commodities are natural resources in their raw form and their supply and demand can be limited by reserves (eg oil), the weather (eg coffee) or availability of land (farming livestock). Each unit of a certain type of commodity is standardised to assist in trading so that when buying or selling there is certainty in what is being traded. Investing in commodities can be either directly through a commodity exchange or through managed funds. Investing in commodities is not for everyone, but they do tend to be negatively correlated to equity markets and can potentially provide an attractive inflation hedge.

¶9-335 Derivatives Derivative markets allow investors to shift their risks. The derivatives markets developed out of the need of some market participants who want to protect themselves against loss and are referred to as hedgers. Such participants include producers, corporates, banks and fund managers. In the derivatives markets, hedgers can reduce the risk associated with an asset they hold by complementing this with the use of derivatives as a hedge. This transfers a specific risk to another party that is willing to underwrite the risk in the expectation of a profit. In contrast, speculators may use derivatives to increase risk by trading in a derivative in an unhedged manner. If inappropriately managed, a derivatives position can hold a large amount of inherent leverage which can significantly increase the risk involved in speculative trading if it is not managed in a highly sophisticated manner. Options An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specified price (strike price) at any time up until a specified date (expiry date). The seller (writer) of the option has an obligation to buy or sell if the buyer exercises that right. The buyer pays a fee called a premium to the seller (writer) of the option. Whereas a call option gives the buyer the right, but not the obligation, to buy, a put option gives the buyer the right, but not the obligation, to sell. A buyer of an option has unlimited upside and the downside is limited to losing the premium paid to the writer of the option. A seller of an option has limited upside (the premium) and unlimited downside. During flat market conditions it is generally best to be an option writer. However, when markets are volatile or are trending strongly either up or down, it is usually better to be an option buyer (calls when rising, puts when weakening). Options trading requires much skill, experience and careful planning and is more difficult than share trading because of the additional time constraint under which an investor’s view about a security must be achieved. For example, an investor who backs a bullish view on BHP by buying the shares can afford to

wait several months or longer for the position to turn profitable. However, in the options market the same investor must also have a view on how much BHP is expected to go up within a specific time period. Any wrong aspects of this view can turn the options position into a loss. The ASX’s website (www.asx.com.au) is a good place to start for further research on options trading. Futures A futures contract is a legally binding agreement to buy or sell a commodity or financial instrument at a fixed price at a specific time in the future. Like the options market, the futures market is also a risk shifting mechanism allowing market participants who are exposed to risk to shift it to someone else. For example, a borrower can shift the risk of higher interest rates to someone else by agreeing to borrow money in the future at a certain rate in the futures market. The risk has been shifted to someone who is willing to make an agreement to lend in the future. This could be a financier who has an opposite risk and thus wishes to insure against falling interest rates. The principle of leverage allows speculators in the futures market to take advantage of price changes on a large amount of the underlying security for a small initial outlay. Hedgers use the futures market to manage risks. By entering into a futures contract, hedgers know in advance the price at which they will buy or sell allowing them to plan ahead with more certainty. For hedgers a favourable price in the physical market is countered by losses in the futures contract. Likewise, when prices move against the hedger in the physical market, this is offset by futures profits. Share Price Index (SPI) futures The Sydney Futures Exchange (SFE) offers the SFE SPI 200 futures contract that tracks changes in the S&P/ASX 200 Index. Each point move in the SPI 200 futures contract is valued at $25. So an increase in the S&P/ASX 200 Index from 4500 to 4501 means that the purchaser of the futures contract has made a $25 profit. Fund managers use SPI futures to protect portfolios against stock market risk. Existing portfolios lose value during market declines and fund managers who expect to have funds available for investment are at a disadvantage if the market rallies. As fund managers find it difficult to change their portfolio composition quickly, SPI futures are an important tool. SPI futures allow fund managers to take on a market position quickly, efficiently and at low cost without buying or selling a single share. Fund managers use futures and options to implement strategies in the context of any of the following: • to protect existing market gains • to get set in a market without affecting individual share prices due to large transactions • to obtain short-term exposure to certain assets without buying the underlying securities. Individual share futures Individual share futures are futures contracts that are based on individual stocks listed on the ASX. Share futures are offered on a number of blue chip stocks and offer traders the opportunity to gain leveraged exposure to these stocks for either hedging or speculative purposes. The contract value for share futures equals the contract unit, which is 1,000 shares for most stocks multiplied by the share value. For example, if XYZ shares are trading at $33 the contract value is $33,000 ($1,000 × $33 = $33,000). Contracts for difference (CFDs) CFDs are essentially an over-the-counter derivative contract that is leveraged, allowing investors to speculate on the rise or fall of an underlying investment without the need for ownership of the actual security. There is an agreement between an investor and provider to settle the difference in cash between the price at which the CFD position is opened and the price it is closed, with reference to the underlying security. The provider of the CFD usually requires a cash deposit (initial margin) as a proportion of the underlying exposure of each CFD. The investor’s position is then marked to market each day, and as such they

could be subject to a margin call if the account value falls below the minimum requirement. One of the benefits of CFDs are that the up-front costs are a fraction of the price of real shares as the remainder is borrowed via the provider. However, on the other side of the equation, they are geared investments, and as such any losses will be magnified. In addition, they convey no right or interest in the underlying security nor do they entitle holders to any voting rights or franking credits associated with them. These types of investments are not suitable for everybody. While they have some advantages, they are complex high-risk investments. As such investors need to be experienced, have a thorough understanding of the workings of CFDs, as well as having the financial capacity to take on the risk involved as detailed in the following table. Experience

Previously day-traded shares, options, futures or other short-term derivatives, especially in volatile markets.

Knowledge

A thorough understanding of how CFDs work, including the trading rules and trading platform. Always read the product disclosure statement.

Risk control

Ensure that an appropriate trading system is in place to stop unacceptable losses.

Financial capacity Capacity to pay for any losses that arise through using CFDs. Source: ASIC

¶9-340 Warrants It is easier to understand the many different types of warrants when they are categorised into the following two categories: Trading warrants: Trading warrants are designed for traders looking for short-term leveraged exposure to a stock, currency or index. They allow traders to profit from both falling and rising prices in markets for which trading warrants are available. The prices of trading warrants are inherently volatile, which is often exacerbated by their low liquidity. Trading warrants are only appropriate for traders who have a high tolerance for investing in volatile assets. Investment warrants: Investment warrants offer investors long-term leveraged exposure to the underlying security. Investment warrants have a lower risk profile than trading warrants and include instalment warrants, rolling instalment warrants, capital protected warrants and endowment warrants. Instalment warrants Instalment warrants are the most popular type of warrant among retail investors. They give investors the right to buy the underlying security through payment of several instalments during the life of the warrant. Although this can vary, the gearing level of instalment warrants is around 50% when they are issued, indicating that 50% is paid up-front. Instalment warrants have a life of anywhere between 12 months and 10 years. An interesting feature of instalment warrants is that investors are entitled to dividends or distributions and franking credits paid by the underlying security during the life of the instalment. This feature makes instalment warrants a popular investment for SMSFs in certain situations. Instalment warrants offer SMSFs a way of gaining long-term leveraged exposure to equities. Since 24 September 2007, superannuation funds have been able to invest in most types of traditional instalment warrants, as well as in other types of investment arrangements that operate in the same way. It is important to note that an SMSF which invests in an instalment warrant will also have to comply with other superannuation rules. See ¶5-360.

¶9-345 Hedge funds It is difficult to provide a precise definition of hedge funds. Generally, they are private investment funds

permitted to employ a wide range of strategies in order to achieve a targeted level of return while controlling risk. Many traditional investment funds do not permit many of these strategies, which include using leverage, short selling and derivatives. There are four core categories of hedge fund managers: (1) long/short equities (2) relative value (3) event driven (4) global thematic trading. Long/short equities The fund buys securities that it believes are likely to go up in value and short-sells those securities it expects to drop in price. Relative value The fund attempts to identify securities that are currently trading above or below their true or intrinsic value. Strategies such as convertible bond arbitrage and fixed income arbitrage are used to take advantage of these opportunities. Event driven The fund takes positions in financial instruments to take advantage of specific events. For example, this may be a suspected merger or suspected bad news. Global trading The fund attempts to profit by anticipating movements in prices or currencies based on analysis of trends and calculation of values. The range of possible strategies allows hedge funds to generate positive returns in a variety of market conditions. Consequently, they usually attempt to target an absolute return rather than a return relative to a certain benchmark. This is the attraction of hedge funds, the prospect of positive returns in either rising or falling markets with low correlation to traditional asset classes. The hedge fund industry has grown at a fantastic rate over the last decade. There are now over 10,000 hedge funds operating throughout the world. The returns generated by hedge funds are more heavily related to the skills of the relevant manager than is the case for traditional asset classes, and therein lies the risks involved. Poor judgment by the manager or overexposure to a particularly bad strategy can result in negative returns. Hedge funds also have much lower levels of liquidity than standard managed funds. This will depend on the strategies involved but some funds redemptions may take anywhere from one to six months. Hedge funds traditionally were only accessible to larger investors and institutional clients. However, smaller investors are now able to access individual hedge funds with lower minimum investments as well as “Fund of Funds”. A Fund of Funds invests in a selection of hedge funds, carefully researched to ensure a range of strategies and a range of manager skills are employed. Using a Fund of Funds option is also a means of reducing the manager and strategy risk described above.

¶9-350 Hybrid securities Hybrid securities have become popular in recent years as investors have sought higher yielding investments. Examples include income securities, convertible preference shares and reset preference shares. Hybrids are an alternative means for companies to raise capital to the traditional measures of issuing

equity or raising debt. They pay a fixed or floating rate of return for a fixed time frame, at the end of which the investor may have the option to convert the security into a reference security or cash. Hybrids are also listed on the ASX, allowing investors some means of assessing value and some liquidity. It is a misconception to group all hybrid securities as fixed interest or equities. The structure of each hybrid is different, some will exhibit more fixed interest characteristics and some more equity characteristics. Therefore, their listed price may be heavily related to the credit risk of the underlying company or the share price of the underlying security.

¶9-355 Private equity Private equity refers to investments in the equity of unlisted companies. Private equity provides a company with capital at various stages of the business, from early stage seed money during a company start-up, or later stage capital expansion in return for equity in the company. The earlier the stage of the project at which the investor gets involved, the higher the potential financial reward — and the higher the risks. Most start-up companies fail within the first five years of operation. While well-established overseas, Australian expertise in the private equity market is limited, this market is expanding and could provide investors willing to take on the risks with interesting opportunities. Exposure to this type of investment can also be gained via fund managers that offer pooled investments with a small company or venture capital bias.

¶9-360 Tax-effective investments Tax-effective investments in Australia usually refer to agricultural projects that offer investors indirect involvement in primary production. Generous tax deductions are an incentive for getting involved in such projects. Tax-effective investments generally provide tax benefits at the front end, in the form of tax deductions for expenses paid. Tax-effective investments can also include investments such as agricultural, entertainment, franchises and film schemes. Rather than focusing entirely on the tax savings from tax-sheltered projects, they are best integrated with other mainstream financial strategies and treated as an investment alternative rather than a tax strategy. The Australian Taxation Office (ATO) has focused heavily on this sector in recent years, disallowing deductions for investments made in projects considered primarily “tax-driven”. Investors can be provided with more certainty by only choosing projects that have an up-to-date product ruling issued by the ATO. Agricultural projects An investor in an agribusiness project becomes a grower and purchases the “right to the crop”. The grower engages a manager to establish and/or maintain a plantation or orchard and then harvest, process and market the produce. Expenses such as the up-front establishment/management costs and all ongoing costs are tax deductible and can be offset against other taxable income. All proceeds from the sale of the crop are taxable at the grower’s marginal tax rate (MTR). Because of the front-end tax deductibility of tax-effective investments, the higher the taxpayer’s marginal tax rate the lower the entry cost. This is why these investments are attractive to high-income earners. Agribusiness investments generally offer two types of income: (1) long-term lump sum payments on maturity (eg pulpwood plantations over 10 years or hardwood plantations over 25 to 30 years) (2) annuity income streams where, once the plantation is established, the annual harvesting of the crop produces ongoing income (eg olive groves, almond orchards or vineyards). The area has undergone some change in recent years as the ATO reconsidered its views on the deductibility of investments in these schemes. Investors in forestry schemes were not impacted and can be entitled to an up-front statutory deduction for expenditure. A test case was put to the Federal Court in relation to non-forestry schemes (Hance v FC of T; Hannebery v FC of T 2008 ATC ¶20-085), and in December 2008 the Full Federal Court of Australia ruled that

contributions to non-forestry schemes can be treated as tax deductible as they are essentially “carrying on a business”. The ATO has subsequently confirmed this decision stating in a media release that investments in MIS arrangements which are broadly similar to the test case are deductible. As such, investors in agricultural schemes can potentially receive a tax deduction for their investment. This is subject to the terms of the applicable product ruling being met and individual circumstances. While this area retains its tax advantages, investors should seek independent research validating the long-term prospects of the particular project. Films Investing in films is popular due to tax concessions which provide for a deduction for investment in Australian films. Some investors in their zealousness to generate tax deductions forget that the overriding objective of investing must always be to generate positive long-term returns. As there are only a limited number of truly successful films, investors should seek qualified expertise in assessing such investments.

¶9-365 Collectables Investing in collectables refers to the purchase of valuables such as works of art, antiques, coins and vintage cars. Collectables are believed to appreciate in price over time. Collectable investments are often accumulated for non-financial reasons and therefore inexperienced investors should seek advice or leave this asset class to knowledgeable collectors.

¶9-370 Socially responsible investments (SRIs) Socially responsible investing (also known as ethical investing) focuses on those companies that support high ethical standards. It may involve some kind of screening criteria to exclude companies that do not meet a specified minimum standard. This kind of investing is becoming increasingly popular with some large industry superannuation funds and some major domestic fund managers offering ethical options. An issue for SRIs is that an appropriate definition will vary from person to person. For example, some may see investing in a mining company as completely unacceptable. Others may consider investing in a mining company acceptable if the company’s mining standards meet certain environmental standards. It is important that investors understand and are comfortable with the ethical criteria used. The premise behind ethical investing is that companies who are managed to provide a long-term sustainable business will be more successful than those who do not.

¶9-375 Cryptocurrency Cryptocurrency is virtual or digital money that uses cryptography – code, for security. The first cryptocurrency, called bitcoin, was created in 2008 and released as software in 2009. It is part of a decentralized global payment system where online transactions take place between users, with minimal fees. The Australian Tax Office (ATO) views cryptocurrency investments as property and, as such, treats them as assets for capital gains tax purposes (¶2-100). Cryptocurrency owners and traders are required to maintain records in relation to their holdings including records relating to the purchase, sale and transfer of cryptocurrency. In April 2019, the ATO announced that it would collect data from cryptocurrency designated service providers to identify individuals or businesses who have or may be engaged in buying, selling or transferring cryptocurrency (during the 2014/15 to 2019/20 financial years) to ensure that individuals are meeting their obligations in relation to transactions and ownership. These obligations include registration, lodgment, reporting and payment responsibilities.

¶9-380 Asset allocation

Asset allocation is the single largest factor in determining the actual investment outcome for an investor. It is the process of allocating various asset classes across the portfolio. Analysis has shown that asset allocation accounts for in excess of 90% of the volatility of return of a portfolio. Views in the industry differ as to exactly what kind of asset allocation is appropriate for each client type. However, there are two types of asset allocation that should be recognised — strategic and tactical. Strategic asset allocation Strategic asset allocation (SAA) refers to the long-term benchmark of the portfolio. The appropriate SAA for each client depends on the elements discussed at the beginning of the Investment Asset Classes section of this chapter (¶9-070), the client’s goals, required time frame and acceptable level of volatility. The ideal allocation is one that is set to achieve the designed return within the required time frame with an acceptable level of risk. Various tools are used to set these allocations including analysis of historical returns and medium to long-term forecasts. It is common practice to have up to five or six different SAA profiles to suit various types of clients. There are three common means of using SAA for a client: (1) dividing the asset classes into two categories — growth and defensive (2) setting a fixed percentage allocation of the portfolio to each asset class (3) stipulating operational ranges for each asset class. In some cases, a combination of these three approaches is used. Some examples of strategic benchmarks are set out in the table below. Conservative/Capital Moderate/Conservative stable balanced Time frame

Balanced

Growth

High growth

3+ years

3–5 years

5+ years

7–10 years

12 years

CPI + 2.0%

CPI + 2.5%

CPI + 3.0%

CPI + 4.0%

CPI + 4.5%

Aust. equities

11

17

23

30

28

Int’l. equities

14

21

27

36

43

Property

6

7

12

12

6

Alternatives

23

25

27

21

19

Fixed interest

16

10

6

0

0

Cash

30

20

5

1

4

Return objective

Source: CareSuper, AustralianSuper Each of the five benchmarks has a return objective. In order to achieve a higher return objective, a greater weighting is given to the growth assets (shares and property) and the time frame must lengthen to compensate for the higher short-term risks associated with investing in these more volatile assets. Tactical asset allocation Tactical asset allocation (TAA) is designed to periodically fine tune an investment portfolio with the objective of enhancing total return. TAA involves re-weighting the portfolio towards those asset classes expected to perform well in the short term (usually less than a year). These movements will be within the ranges set by the strategic benchmarks so it only aims to generate outperformance at the margin. You may also hear the term

dynamic asset allocation (DAA) which is similar to TAA but with a longer time frame. Tactical asset allocation requires forecasting skills Forecasting skills are a prerequisite for the successful inclusion of TAA. Examples of methodologies used for implementation of TAA include: • momentum and technical analysis • subjective assessments of relative asset class attractiveness • quantitative input and analysis. The problem with TAA is that short-term forecasting is extremely difficult because investment markets and economies are always vulnerable to unexpected news and events. Examples include natural disasters, wars, unexpected economic news and government announcements on new initiatives. These effects may smooth out over the long term but can cause havoc with a TAA strategy. Contribution to performance As mentioned above, asset allocation is a critical factor in determining an investor’s return. However, since TAA is only employed to add value above the long-term return expectations, it is not a major component of overall performance. Carefully implemented, TAA can certainly add value but evidence is mixed as to whether it is worth the significant resources required to make it work. Many financial planning organisations see the use of TAA as high risk since it could force a portfolio to endure some periods of below benchmark performance. The costs of enduring poor performance relative to peers may far outweigh the benefits of some periods of marginal outperformance. Therefore, many financial planners invest portfolios according to SAA benchmarks alone and review these every few years.

¶9-400 Investment management styles Financial planners should understand there are a number of different investment styles that managers may employ. At the first level is passive management versus active management. Passive, or index fund managers attempt to replicate a chosen index, for example, the S&P/ASX 200. Index managers have a number of different styles they can employ to replicate the chosen index and their fees will be quite a deal lower than that charged by active managers. Active managers attempt to use their skills to either outperform a certain benchmark. Due to the research usually required, their fees are higher than passive managers. It is of course necessary to judge the success of active managers only after taking into account any fees incurred. In certain asset sectors, with a narrow investment universe such as Australian Property, it has become increasingly difficult for active managers to consistently outperform, due to the lack of opportunities available to add value. In asset classes with broader opportunity sets, such as international equities, however, top fund managers have been able to beat their chosen benchmarks. Within each asset class, there are a number of different styles that can be utilised by active managers. For example, within equities there are two popular styles: growth and value. A number of managers choose to employ a combination of these two styles or even ensure their portfolios are perfectly balanced between them (known as style neutral). When investing in funds using active management, it is important to diversify your manager blending and be aware if your portfolio has any unintended style biases.

INVESTMENT PRODUCTS ¶9-420 Direct investing Investing directly into the Australian share market has become increasingly popular. Due to online trading,

the cost of direct investing has reduced over the years — transaction costs can be as low as $10 per trade, while the average cost is approximately $20 per trade. International share investing is also possible through online and traditional stockbrokers in major offshore markets such as the United States, though at a higher cost. Investing in other asset classes such as government or corporate bonds usually requires larger investment amounts. Direct property investing has always been popular in Australia despite high transaction costs and low liquidity. Professional management and diversification give pooled investing through unit trusts a significant advantage when investing smaller amounts. A service that was introduced in 2014 is the mFund Settlement Service through the ASX. This service enables investors to buy and sell units in selected unlisted managed funds directly with the mFund issuer via a stockbroker or advisory service. That means an investor can invest in and track their managed fund investments using the same systems used for shares and other securities. It is important to note that mFund products are not directly traded on the ASX meaning that investors are not trading with other investors. The price of units is set by the fund manager as per a standard managed fund investment and not on a traded market, as is the case in share transactions. An investor’s holdings with the mFund service are held electronically and will be linked to the same Holder Identification Number (HIN) used to hold other investments transacted through ASX, such as shares. The service also takes away the need to complete an application form as it is all done online.

¶9-430 Master trusts and wrap accounts Master trusts and wrap accounts essentially provide a central administrative hub for accessing investments and also a single reporting structure at tax time. These investment platforms allow investors to access a variety of fund managers and investment options through one single entity. Generally, there is a wide choice of investment options that cater for all individuals and their risk preference. Some platforms will also offer access to direct shares. While master trusts and wrap accounts both provide an administration service, there are some key differences in their structure. Most notably, this lies with the ownership of the assets. Under a master trust arrangement, a trustee owns all the assets on behalf of the investor. On the other hand, wrap platforms operate under a custodial service arrangement whereby assets are held in the investor’s name. Thus, investors that want to leave a master trust arrangement will probably be subject to capital gains tax (CGT), whereas those that wish to leave a wrap account will not necessarily incur a CGT liability provided they transfer the underlying assets. Another key difference between master trusts and wrap accounts is that fee bundling is generally only available through a master trust. All costs are incorporated into the unit price of the underlying investments. Alternatively, wrap accounts itemise expenses, providing better fee transparency. Also, some fees in wrap accounts may be tax deductible for the client.

¶9-450 Unit trusts Unit trusts or managed funds are the mainstay of the wholesale and retail funds management industry. Although the diverse range of investment options makes unit trusts seem complex, the underlying structure is reasonably simple. Broadly, a fund manager offers investors the opportunity to pool their money with other investors and buy into a portfolio of assets. Investors gain beneficial interest in the asset pool to the extent of the proportion of their investment to the total asset pool. Unit trusts are run according to the rules established in the trust deed or constitution, which must comply with the Corporations Act 2001. There is an extensive and growing body of trust law. Investors learn about the offer through a Product Disclosure Statement (PDS), which is based on the trust deed and is also regulated by the Corporations Act.

When a unit trust is developed, there is usually only a small amount of money put into the pool by the manager called the “corpus”, which forms the pool. The unit price is usually struck at $1 and investors are given one unit for every $1 they invest. Once the money in the pool is invested in assets, the unit price will vary depending on the value of the underlying assets. However, cash management trusts and some other income-only trusts are priced differently because the value of the underlying assets usually does not change. Interest or income is accumulated and either used to buy additional units or paid out to unitholders. The unit price remains at $1. The diagram below illustrates the flow of money within a unit trust investment.

Units are priced by dividing the trust assets by the number of units on issue, resulting in the net asset backing. Some managed funds have a brokerage spread to ensure additional transaction costs are covered. Unit trusts make periodic distributions, which are usually paid at either quarterly or half-yearly intervals. Distributions are audited and some trusts also offer a distribution reinvestment program. There are two methods of calculating distributions: unit trust days and ex-date. Essentially, unit trust days seeks to calculate the total amount of distributable income and apportion it according to each investor’s proportional holding and tenure within the trust. Ex-date unit pricing is how the share market works. As each day passes, the unit price is calculated, including the amount of accrued distributable income available. As new people enter between distribution periods, they “buy” their distribution by paying a higher price for their units. At ex-date, they actually get back some of their capital. The seller of the units receives a proportion of the distribution in the higher price they receive for their units. Neither system is perfect, but they both provide for a measure of equity. Unitholders are entitled to audited accounts and receive a tax statement at the end of the financial year. Unit trust fee structure Unit trusts may charge two types of fees — entry/exit fees and ongoing management fees. Entry/exit fees Entry and/or exit fees are usually expressed as a percentage of the money invested or withdrawn. Exit fees are generally levied as an alternative to entry fees. Therefore, they apply to motivate unitholders to retain funds in the unit trust until the entry costs are recovered. Ongoing management fees Ongoing management fees are deducted from the fund’s net asset value. These fees include the manager’s, auditor’s and custodian’s fees and other fees stipulated in the trust deed. As the ongoing management fees are deducted directly from the fund’s assets, the lower the fees, the more left over for the investor. Fund managers are required to calculate an indirect cost ratio (ICR), which is disclosed in the fund’s PDS. The ICR is used to compare the cost of investing in one fund with that of another fund. The ICR includes any performance fees in addition to the regular management expenses (MER) where the manager participates in the outperformance over a predefined benchmark. With such arrangements there is usually a “high water mark” to ensure an accumulated hurdle is in place so a manager cannot ignore underperformance and collect for only the outperforming periods. When comparing the cost structure of different funds it is important to bear the following in mind: • some asset allocation strategies are more costly to manage and implement than others • the cost structure is influenced by the fund’s management style

• ICRs must be interpreted in the context of the fund’s performance • it is difficult to provide an indicative ICR for master trusts for individual clients. The total ICR for a client is the sum of the ICRs of the master fund, plus the weighted ICR of the products they have selected. Fees have reduced substantially over the last decade. In addition, commissions were historically incorporated into the bundled ICR of master trusts. However, under the government’s FOFA reforms, trailing fees and commissions were prohibited from 1 July 2013 for new clients in a product (see ¶8-150).

¶9-470 Cash management accounts A Cash Management Account (CMA) is similar to a bank account which can be used as a cash hub for a client’s different investments including a Self Managed Superannuation Fund. A CMA can only be offered by a regulated banking institution and earns money market interest on cash balances. CMAs may be eligible for cover by the Australian Government’s Financial Claims Scheme also known as the Government Guarantee. Cash management trusts (CMT) while less prevalent, invest in bank bills and other secure, short-term securities. CMTs require a PDS and you invest in units which are generally priced at $1. Usually cash management trusts have no entry or exit fees and offer instant redemption and phone redemption facilities.

¶9-480 Australian fixed interest trusts Australian fixed interest trusts give investors access to a range of fixed interest investments with risk and return objectives. They invest in bonds, fixed deposits and other interest-bearing securities, which may be short, intermediate or long-dated securities. Investors have the choice of either index management or active management. With index management, the manager is aiming to replicate the benchmark index, whereas with active management, the manager is aiming to pick the direction of the bond market in order to outperform the benchmark index.

¶9-490 Mortgage offset A mortgage offset is a transaction account linked to a home loan. The loan balance is reduced by the credit funds held in the offset account, reducing interest payable. The more savings you have, the less interest you pay. Typically, the home loan rate is higher than what you can earn in a savings account. So, you effectively maintain access to savings and pay off your loan quicker. As you are reducing your home loan debt by your savings account, there is no taxable income and no extra tax to pay.

¶9-495 Mortgage trusts Mortgage trusts invest in mortgages over residential or commercial properties. They also include liquid investments such as cash and fixed interest securities in their portfolios as investors can redeem funds at short notice. Mortgage trusts are an alternative to cash management trusts and fixed interest trusts and do not provide capital growth. As returns vary in line with interest rate fluctuations, mortgage trusts with a predominant exposure to fixed interest rate funding should be less volatile. However, when interest rates rise, investors in these funds are at a disadvantage. Hence, conservative investors favour mortgage trusts with a high exposure to variable interest rate funding, which follow interest rate changes more closely.

¶9-500 Australian property trusts Australian property trusts offer investors a myriad of exposure to different types of properties including: • retail properties

• commercial and industrial properties • tourism and leisure industry properties • CBD properties • fringe CBD properties. Distributions from these trusts may have tax-free or tax-deferred income components from the rents paid on property leases. The tax implications of these income components are discussed at ¶2-205. Growth or decline in unit values arise due to property revaluations. Most property trusts are listed to provide investors with all important liquidity. Some Australian property funds are structured as stapled securities whereby the investor owns two or more entities through a single entity which cannot be traded individually. Typically, one security is a unit trust holding a portfolio of assets and the other operates a funds management and/or development business.

¶9-520 Australian equity trusts Australian equity trusts can be broken into a range of different categories. They may focus primarily on delivering tax-effective income through imputation credits, or try to outperform a specific benchmark, or concentrate their portfolio in one part of the economy such as banks or healthcare, or of companies of a certain size (for example, inside or outside the top 50 companies listed on the ASX). Derivatives may also be used to smooth or enhance performance. It is not always valid therefore, to compare Australian equity trusts solely on the basis of reported performance. Trusts that focus on smaller companies for example, may outperform larger capitalised shares at different parts of the economic cycle, often at the upturn of a cycle. However, these trusts can be expected to exhibit higher degrees of volatility over the longer term. Considerations before investing in these products include: • What is the focus or aim of the fund? • What does the fund invest in? • What is the fund’s benchmark in terms of performance and volatility? • What is the fund’s structure? • Is the fund managed in a tax-effective manner?

¶9-530 International trusts Unit trusts also provide investors with international exposure to many of the asset classes. International trusts thus include: • international fixed interest trusts • international equity trusts • international property trusts. Many of the points raised above for Australian trusts hold for international trusts. It is important to bear in mind that all international unit trusts are exposed to currency risk. Some fund managers implement currency hedging strategies designed to protect portfolios from adverse currency fluctuations. Gains or losses on hedging contracts are taken on the revenue account which can have an impact on income distributions unless the trust has elected to have them taxed on the capital account via

the Taxation of Financial Arrangements. Other funds, particularly equity funds chose to leave their portfolios unhedged, which mean their return can be heavily influenced by movement in the Australian dollar. Investors should also be aware of potential international tax treatment implications. However, the majority of international unit trusts available in Australia are structured so that they are excluded from the Foreign Accumulation Fund Rules.

¶9-535 Listed investment companies and exchange traded funds Listed investment companies (LICs) are similar to managed funds in that they provide investors with exposure to a diversified portfolio of listed stocks, fixed interest, and other securities. Investments in LICs are made via a company structure rather than a unit trust structure, with the company acting as the asset manager. LICs can vary dramatically from offering to offering, and so it pays to be aware of the investment objectives, strategy and structure of any LIC you want to invest in. The fee structure with LICs is often quite different to managed funds. Performance fees, for example, can often be levied. In a number of cases, options may have been issued to investors which could have an impact on the underlying share price. LICs are closed-ended funds and they should trade at or near their net tangible asset (NTA) value. However, market sentiment may play a role in the share price day to day. Investors should be wary of buying LICs trading at a premium or discount to their NTA value and look at the historical trading range. Exchange traded funds (ETFs) are similar to managed funds. They are listed, open-ended and aim to replicate the performance of a chosen index or commodity before fees. ETFs have been around for about 20 years globally, but are a more recent addition to the Australian market. ETFs tend to trade at levels close to NTAs due to the ability of large institutions (authorised participants) to redeem or purchase units directly with the fund provider and thereby profit from any difference between the NTAs and share price. When investing in ETFs, investors should consider the process the issuer uses for replicating the relevant index, the track record of the ETF for replicating the index and the liquidity of the ETF. There is a subset of ETFs called “Smart Beta”. The idea behind “Smart Beta” is an attempt to enhance returns on ETFs that track indices by adding additional screens to the list of securities a particular ETF would purchase. These screens create a variation of the index to offer strategies which include equally weighing the assets of an index, a high yield focus or low volatility to name a few. A further innovation in this space has been the launch of Exchange Quoted Managed Funds (EQMF). These are actively managed funds that are accessed by a similar structure to ETFs and investors can buy and sell these units on the ASX via their stockbroker or financial planner. These funds offer investors exposure to the same investment process employed by the manager for their unlisted funds, but differ in two key ways to ETFs. First, the fund discloses holdings on a quarterly basis, whereas ETFs disclose on a daily basis and second it acts as a market maker for the buying and selling of units, whereas ETFs usually appoint third party market makers. This means any profit and loss generated from the market-making activities is for the account of unitholders in the fund.

¶9-540 Diversified trusts Diversified trusts are a combination of many of the other trusts and thus have a diversified portfolio of securities. The fund manager determines the percentage of the funds to be allocated to each asset class and can change the allocation within the constraints of the fund’s mandate. The benefit of using a diversified trust is that a client’s portfolio can be established with a single investment, with the added advantage of minimum administration. Periodic re-weighting is taken care of by the fund manager inside the trust structure. The disadvantage of these trusts is that the investor is locked into one fund manager who may not have

the same level of investment skill across all asset classes. Furthermore, the financial planner and client have no control over the asset allocation which means that any personal requirements must be carefully matched with the diversified trust. There are various types of diversified trusts, including: Capital stable trusts Capital stable trusts are also referred to as conservative trusts and were created by fund managers to offer lower volatility returns to risk-averse investors. However, they can experience negative returns from time to time. Capital stable funds hold a significant amount of their assets in fixed interest securities and have less exposure to equities and other growth assets. Balanced trusts Balanced trusts aim to achieve higher returns than capital stable trusts over time by “balancing” investments between defensive and growth assets. Typically, around 50% to 70% of the portfolio is invested in growth assets and the remainder in fixed interest related securities. Growth trusts Growth trusts are designed to meet higher investment return objectives. Growth trusts are more volatile than capital stable and balanced trusts because the exposure to defensive assets is kept intentionally low. These trusts generally have most of their assets invested in Australian and international equities. Within the domestic equity allocation, a portion of the funds may be dedicated to unlisted or private capital, small companies and infrastructure projects. International equities may also include exposure to emerging markets and other higher risk equities. Property exposure may be gained through listed, unlisted, syndicated or direct property and may even include some form of property development. Exposure to hedged funds may also be included.

¶9-600 Investment bonds Investment bonds are pooled investments which have underlying assets similar to unit trusts and are issued by insurance companies and friendly societies. However, there are major differences in the legal structure, tax treatment and holding period. Investment bonds retain their earnings, pay tax on the earnings and then automatically reinvest the net earnings back into the bond. Therefore, they do not impact on personal taxation levels. When held for a full 10 years, investors receive the value of the insurance bond tax paid upon withdrawal. There are rules about additional contributions being limited to 125% of the previous year’s contribution and a rebate (offset) system for early withdrawals. Investment bonds pay tax internally at the rate of 30% — the company tax rate. They do not benefit from an exemption level for CGT, so that the effective tax rate on long-term capital gains is 30%. Fees The fee structure for investment bonds is similar to that of unit trusts. The manager is responsible for any other costs and must pay them out of their management fee. There are a large number of bonds that have low or nil entry fees. Low entry fees are often compensated for by higher ongoing fees and sometimes commensurate early exit penalties. Outcomes Investment bonds invest in the same types of assets as unit trusts, but they do not make distributions. The income received is taxed at a maximum of 30% within the bond and then reinvested, and the tax liability is not the responsibility of the investor. The issuer of the bonds is considered a professional investor and capital gains are taxed as ordinary income rather than under the CGT provisions. As such, all investments are on revenue account. This means tax liabilities for capital growth are provisioned for within the bond and are not the responsibility of the investor. As capital profits are realised, the tax liability is provisioned for and paid from the bond. Investment bonds can be purchased in joint names. Investors can name a beneficiary. Upon death of the

owner, the cashed-out value of the investment bond is tax paid in the hands of the beneficiary, which makes investment bonds a possible tool in estate planning. Franking credits can be used to reduce tax liability within the investment bond.

¶9-610 Managed accounts Separately Managed Accounts (SMA) and Individually Managed Accounts (IMA) have been slowly gaining in popularity in Australia in the past few years but have been popular in the United States for some time. They work similarly to a managed fund in which an investor can access professional investment management over a pool of securities. However, the investor owns the securities directly rather than through a trust. A simplified way of looking at the difference between an SMA and an IMA is that under an SMA you invest in a standard model portfolio whereas in an IMA a portfolio would be designed for you. While there are variations between the products available, managed accounts allow the investor to access the income as well as taxable gains and losses directly. Through a trust, investors may often inherit capital gains from others and distributions are also often at the discretion of the manager. In effect, managed accounts are not unlike the discretionary management offered by stockbrokers with the benefit of consolidated reporting. Some products allow tax planning at end of year (realisation of losses, for example, for tax purposes) and some allow investors to bring in existing share holdings. Diversified portfolios are gaining popularity in managed accounts. They allow investors to have a portfolio that covers multiple assets classes in the one model portfolio that meets their personal risk profile. Certainly the transparency and tax effectiveness of managed accounts may appeal to those concerned by not being able to get full disclosure of the activities of traditional managed funds, which may only report their list of shareholdings on a quarterly basis.

PERFORMANCE MEASUREMENT ¶9-700 Performance measurement Managed funds should be reviewed and assessed periodically. The fund’s performance needs to be compared to the objectives originally stated. These objectives may be to outperform inflation, outperform the relevant index or provide a certain level of income. They also need to be compared with other products. In the funds management industry, services are available that specialise in: • measuring fund manager and product performance • establishing benchmarks against which to compare fund managers’ portfolios • making managed fund recommendations to both retail and wholesale investors.

¶9-710 Industry benchmarks for investments Some investment managers aim to outperform inflation as measured by the CPI. This goal is usually expressed as a percentage, eg 3% above inflation. The target figure is then further qualified by indicating over what time period this objective should be measured against such as over five years. They may also indicate the likelihood of a loss over this time frame. For example, the 3% figure is one that should be achieved at least 75% of the time. Generally, the higher the percentage above inflation, the lower the percentage of time over which it is expected to be achieved. The S&P/ASX 200 Index is the most frequently used benchmark against which the performance of an active Australian equity fund manager is measured. Since an investor can achieve index performance by investing in a low-cost index fund, an active fund manager is expected to provide outperformance to compensate investors for the higher fees paid.

There are a number of statistical measurements which can be applied to assess a manager’s skill in adding value over the benchmark return (referred to as attribution analysis). However, it is a difficult task to consistently exceed benchmark returns, and recent outperformance may simply reflect strong performance in that fund’s style, hence the commonly quoted mantra in investment management: “past performance should not be judged as a reliable indicator of future performance”. It is common industry practice to compare funds returns against widely recognised financial benchmarks. An indicative set of benchmarks are set out as follows: Benchmarks Investment option

Benchmark    (before fees)*

Emphasis Short-term income

Long-term income

Capital growth

High

High

Low

Combination of 70% of a defensive benchmark and 30% growth benchmark over two-year periods

Medium

Medium

Medium

Combination of 30% of a defensive benchmark and 70% growth benchmark over four-year periods

Growth

Low

Low

High

Combination of 20% of a defensive benchmark and 80% growth benchmark over five-year periods

Short-term money market

High

N/A

Nil

Bloomberg AusBond Bank Bill Index over one-year periods

Australian fixed interest

Low

Medium

Nil

Bloomberg AusBond Composite Index

Australian shares

Low

Medium

High

S&P/ASX 200 Accumulation Index

Nil

Nil

High

MSCI World Index (exAustralia) in $A with dividends reinvested

Conservative

Balanced

International shares

* Manager returns are commonly reported net of fees and charges but before tax. In this manner an investor can see as whether or not the manager has been able to add value over the benchmark after fees. Sometimes the peer group approach is used to monitor the relative performance of fund managers. It is the fund manager’s goal to outperform these peers. Using a peer group as a benchmark has its limitations. In the first instance, if the manager selects their competitors, there is the possibility of choosing a non-representative group. Secondly, investors are more interested in how their chosen fund manager performs against all other available choices (ie index funds). The statement that their manager “outperformed the peer group” is not much consolation to investors if the peer group as a whole underperformed. A more useful analysis is provided by a comprehensive snapshot showing the performance of a particular fund against all of the following:

• the appropriate index • the average manager return • the quartile manager’s returns • the volatility of returns. To be truly useful, this data should be measured over various periods in order to gain an insight as to the consistency of the manager’s performance over time.

¶9-720 Risk assessment A benchmark comparison can be a snapshot of a year’s performance or it can be extended to compare the risk-adjusted performance of different managers. In the following chart, a grid is set up with risk along the horizontal axis and return along the vertical axis. The manager’s risk-adjusted performance is then plotted as follows:

Manager A is in the optimum situation because it performed as well as Manager C, but with less risk (as defined as the volatility of returns). Manager D offered low risk, but also low performance. Manager E is in the worst position because the portfolio underperformed and had a high level of risk. A variation of this approach is the “snail trail”, where the same set of axes is used but with a manager’s performance plotted over time. A line is drawn between the points so that the manager’s performance over time can be observed. If the snail trail shows the manager just moving about in the bottom right corner, the manager has much work to do to get their performance back on track. If the manager is moving from the bottom right into the top left, their risk-adjusted performance is improving. Snail trails can be used to determine an appropriate mix of managers in a multi-manager fund. Portfolios, consisting of different weightings and different sets of managers, are constructed and composite snail trails developed. The snail trail which shows the best risk-adjusted performance over time indicates a good mix of managers. However, as with all research, it is based on historical data which may not carry through to future outcomes. Summary Performance assessment is complex and detailed. By definition, it is always based on past performance, and many studies show past performance is not necessarily a good indication of future performance. Nevertheless, tools such as snail trails can give an indication of managers who have had consistent riskadjusted performance over time. While generally no manager is consistently the top performer, managers who remain in the top quartile over time implement reliable and proven investment strategies. In addition to quantitative analysis, asset consultants assess fund managers on a qualitative basis. Qualitative analysis aims to determine how managers behave by studying their people and their investment processes. By monitoring these features, they hope to identify where potential changes may either improve or detract from performance.

¶9-800 Managed funds research

Most financial planning dealer networks provide their planners and para-planners with an Approved Product List (APL). It provides a detailed list of approved products that the dealer group has researched and approved for use by planners in a client’s portfolio. It may contain managed funds, insurance bonds, direct shares, structured products and, in some cases, risk products. Both external and internal researchers look for fund managers and products that provide true-to-label and consistent performance. While the process and methodology may differ, most consider: • the financial viability of the manager • the expertise of the investment management team • the historical performance (usually risk-adjusted) • the resources available to manage money, service clients and grow the company • the consistency in achieving benchmarks by using the stated process • the compliance track record • the staff and management stability. Research houses have much influence over the financial success of new entrants and/or products to the market. It is difficult for a new entrant or product to become accepted because most research houses and dealer groups are wary of recommending a product that does not have a solid track record. The trend towards offering in-house master trusts or wrap accounts has also made it more difficult for new managers to gain funds under management as the dealer groups may have long-established relationships with their existing investment managers. Many smaller dealer groups rely on the formation of their Approved Product List with the assistance from research houses. Others might employ an asset consultant to assist them in creating their own list. Many of the larger networks have substantial research teams themselves. There are also differences in how strictly planners must adhere to the Approved Product Lists and the process for the inclusion or exclusion of a manager or a product. Financial planners need to understand how their dealer group’s Approved Product List is managed. However, it is not sufficient for a financial planner to rely on the list to meet their obligation to “know the product”. They must also undertake their own analysis to understand a product and ensure it is suitable for the client before recommending it.

¶9-815 Portfolio reviews Ongoing portfolio reviews are an integral part of the financial planning process. Portfolio reviews are important because many aspects of a client’s financial situation can change during a year, rendering previous advice obsolete or ineffective. Investment performance reviews, including reviews of the client’s superannuation fund(s), personal investments and any gearing packages are vital. Broadly, performance should be compared to established benchmarks, relative manager performance of fund managers, and client objectives. Where the client is invested across a number of asset classes, re-balancing may be required. Any changes to the strategic or tactical asset allocation are usually addressed during these portfolio reviews. Furthermore, any new or pending legislative changes may change the attractiveness of certain investment products or portfolio strategies. From time to time, fund managers may also unexpectedly change their strategy for a particular fund. This necessitates a switch to a new fund if the altered strategy does not suit the client’s requirements. Financial planners also need to investigate further if a managed fund within a client’s portfolio consistently underperforms. Temporary underperformance is caused by fund managers being out of sectors or individual stocks that have performed strongly. This in itself is not necessarily sufficient reason to switch to another fund manager. However, if a managed fund continues to underperform relative to similar funds

over several quarters or more, financial planners should step up investigations as this may indicate persistent underlying problems with the management of the fund. Portfolio reviews are also an excellent opportunity to enhance and reinforce the client/financial planner relationship. Research shows clients do not generally change advisers because short-term returns are below expectations. However, when clients believe the financial planner is ignoring them, this is often a catalyst to look for a new financial planner. Regular portfolio reviews are thus a good way of cementing a relationship.

SALARY PACKAGING The big picture

¶10-000

Salary packaging basics What is salary packaging?

¶10-010

Employer considerations in salary packaging

¶10-020

Employee considerations in salary packaging

¶10-030

Total employment cost

¶10-040

Effective salary sacrifice arrangements

¶10-050

What benefits can be salary sacrificed?

¶10-060

How the tax rules work The basic tax rules around income, benefits and salary packaging ¶10-200 Interaction of FBT and income tax

¶10-240

Valuing salary sacrificed benefits

¶10-260

Taxable fringe benefits Packaging taxable fringe benefits

¶10-300

Cars (motor vehicles) as fringe benefits

¶10-310

Tax consequences of providing car parking

¶10-320

Income tax and FBT treatment of loans

¶10-340

Living-away-from-home allowance

¶10-350

Meal entertainment provided to employees

¶10-370

Excluded from FBT rules Employer arrangements excluded from FBT

¶10-400

Salary sacrifice into superannuation

¶10-430

Employee share schemes

¶10-470

Exempt fringe benefits Packaging exempt fringe benefits

¶10-500

Laptops and work-related equipment

¶10-520

Frequent flyer benefits

¶10-530

In-house child care

¶10-540

Awards for long service

¶10-550

Other exempt benefits

¶10-570

Reductions in FBT Increased savings from reduced FBT

¶10-600

Employee contributions reduce FBT

¶10-610

Exempt and rebatable employers

¶10-620

Otherwise deductible rule

¶10-630

Remote area benefits

¶10-650

Expatriate and visiting overseas employees

¶10-670

Case studies Understanding the case studies

¶10-700

Case study one

¶10-710

Case study two

¶10-720

Case study three

¶10-730

Case study four

¶10-740

¶10-000 Salary packaging and financial planning

The big picture What is salary packaging? Salary packaging is the incorporation of a range of benefits and salary in an employee’s remuneration. It is done for a variety of reasons, most commonly tax effectiveness and convenience for the employee. ¶10-010 Reportable fringe benefits: Reportable fringe benefits are included in an employee’s adjusted taxable income if the total taxable value exceeds $2,000. ¶10-030 Total employment cost: Many employers use a concept called “total employment cost” whereby the total cost of employment is calculated and the employee is entitled to structure their package in a variety of ways within the total cost calculated. The major components of total employment cost are gross salary, cost of benefits plus fringe benefits tax (FBT) and superannuation contributions. ¶10040 Basic tax rules: For salary packaging to be tax effective, the cash salary and benefits must be combined so that the overall tax is reduced. ¶10-200 Interaction of FBT and income tax: The relationship between FBT and income tax can sometimes be complex, but generally, if an item is subject to FBT it will not be subject to income tax. ¶10-240 Packaging taxable fringe benefits: Taxable fringe benefits may be fully taxed or concessionally taxed. Generally, salary packaging of taxable fringe benefits is only advantageous for benefits that are concessionally taxed or where the taxable value can be reduced. ¶10-300 Motor vehicles: Cars are subject to FBT, but often provide concessional taxation treatment when compared to the treatment of salary. Cars are extensively used by employees in their day-to-day activities. Packaging helps to reduce the associated costs and administration for the employee. ¶10310 Superannuation: Superannuation will need to be considered in the context of most salary packages because of the potential for tax savings, the requirement for compulsory superannuation contributions and the necessity to plan for retirement. ¶10-430 Employee share schemes: Benefits under certain types of employee share schemes are excluded benefits for FBT purposes and are eligible for income tax concessions. ¶10-470 Non-profit employers: Non-profit employers may be either exempt from FBT or entitled to a 47% rebate on their FBT liability. This can help to increase the effective benefit to employees up to a concessional cap. From 1 April 2016, meal, entertainment and venue benefits are included in these caps. ¶10-620 Case studies: Salary packaging can provide employers and employees benefits in a range of

circumstances. Case studies one to four illustrate some of these benefits. ¶10-700

SALARY PACKAGING BASICS ¶10-010 What is salary packaging? The purpose of salary packaging is to enable an employee to receive employment remuneration as a taxeffective combination of cash and benefits. The key to tax-effective salary packaging is for the employee to take some of their remuneration in the form of concessionally taxed benefits instead of taking it all as fully assessable salary. This process is called “salary sacrifice” because the employee sacrifices part of their salary in return for the desired benefits. Salary packaging used to be a popular strategy for reducing taxable income to minimise exposure to surcharges and levies, including the Medicare levy surcharge and child support payments. However, fringe benefits (including salary sacrifice to superannuation) are reported through the Single Touch Payroll (STP) system and taken into account in determining liability to such surcharges and levies as well as eligibility for certain tax concessions (¶3-900). Given these changes, salary packaging is now primarily used as a way of reducing income tax if the package includes certain benefits where the resulting fringe benefits tax is less than the income tax otherwise payable. It may also be particularly beneficial for employees of charities and certain concessional employers. Changes to superannuation legislation from 1 July 2017 that allow eligible individuals to contribute to superannuation to claim tax deductions on personal contributions (¶4-220) have provided an alternative to salary sacrifice into superannuation and may continue to diminish the use of salary packaging.

¶10-020 Employer considerations in salary packaging Packaging needs the agreement of both employer and employee. For the employer, packaging has some advantages. It may help the employer to attract employees through flexible pay arrangements and elements of the package may provide employee incentives. However, it can involve significant administrative costs. Therefore, some employers may choose to: • offer only limited forms of packaging (such as offering only a car or superannuation contributions) • limit packaging to particular groups of employees (such as executives) • offer only small benefits (such as laptops) • charge an administration fee, or • limit the benefits to items that provide a specific incentive. Any salary packaging arrangement forms part of the contract of employment and the terms of the contract should be considered when negotiating the arrangement. The terms of any relevant industrial award or other agreement will need to be considered as they may require that an employee receives a minimum amount of salary, superannuation or other benefit.

¶10-030 Employee considerations in salary packaging Employees will generally benefit from salary packaging to the extent that the benefits provided and the resultant income tax savings are of more value to the employee than the salary forgone. Other advantages from the employee’s perspective are that the financial burden of acquiring an item lies with

the employer, who may be able to acquire the item at a lower cost and will usually be eligible for GST input tax credits. If the item is FBT exempt, the benefit of the input tax credit will flow through to the employee.

Note The legislative change that allows employees (in addition to self-employed persons) to claim tax deductions for personal superannuation contributions from 1 July 2017 may require advice to determine which option is more appropriate (¶10-430).

Reportable fringe benefits If reportable fringe benefits have a grossed-up value over $2,000 the total value is reported to the ATO through the STP system. From 1 April 2016, the reportable benefits include the salary packaged meal, entertainment and venue benefits. The value of reported fringe benefits paid in the most recently completed FBT year are included in the income definition of adjusted taxable income which is used to calculate entitlements to certain tax offsets or other government concessions, as well as liability for the Medicare levy surcharge (MLS) purposes. Example In the 2020/21 FBT year, Elvis received reportable fringe benefits of $5,600. This amount is reported by his employer and is included in his adjusted taxable income calculation for the 2020/21 financial year.

¶10-040 Total employment cost For an employer to effectively offer salary packaging there must be a consistent approach to costing and communicating the value of salary and benefits to employees. Many employers in Australia adopt an approach known as “total employment cost” or “total remuneration cost”. In broad terms, the total employment cost for any particular employee (or job category) is calculated by adding up the total of: • the gross salary • the cost of providing the benefits (including any FBT payable by the employer). The total employment cost negotiated with the employee also includes any compulsory or noncompulsory superannuation contributions by the employer, but other on-costs such as payroll tax, workers’ compensation and other levies and charges are generally not included in employee negotiations as part of their package. These are on-costs borne by the employer. The total employment cost provides the foundation on which a package can be created by establishing an overall amount from which the cost of individual reward elements can be deducted. In this way, an employee may be given the choice of making up the total employment cost in a number of ways, depending on the benefits desired. Each benefit will have its own cost for the purposes of the total employment cost. This cost will be affected by the amount of FBT payable. If the benefit is FBT exempt, or is entitled to concessional FBT treatment, the cost may be lower than if the benefit is fully taxed. From 1 January 2020, employers can no longer use salary sacrificed superannuation contributions to cover compulsory superannuation guarantee (SG) contributions. This reduces the risk that employees will be disadvantaged and face a reduced total employment cost.

¶10-050 Effective salary sacrifice arrangements

A salary sacrifice arrangement (SSA) often involves a decision by an employee to receive remuneration in the form of a benefit or superannuation contribution, as opposed to receiving it as salary. Such an arrangement is referred to as an SSA because pre-tax salary is forgone (sacrificed) by the employee in favour of employer-provided benefits. The Australian Taxation Office (ATO) has taken the position in Taxation Ruling TR 2001/10 that an SSA will be effective where the arrangement is negotiated before the employee has earned the entitlement to receive the relevant amount as salary or wages. An amount that an employee has already become entitled to, but is subsequently sacrificed to superannuation, will be assessable income of the employee. Similarly, in the case of bonuses, the arrangement will need to be negotiated before the employee has earned the entitlement to receive the bonus. However, the taking of leave that accrued before the commencement of an SSA will not cause the SSA to be ineffective (Addendum TR 2001/10A). Example 1 Effective salary sacrifice arrangement Megan receives a salary of $130,000 per annum. Under her employer’s discretionary bonus scheme, Megan is required to elect annually whether she wishes to have her bonus, if any, deposited to her bank account as salary or paid to her superannuation fund as employer superannuation contributions. On 1 June 2020, Megan submits a form electing to have any bonus for that (calendar) year contributed to her superannuation fund. On 15 July 2020, the employer decides that Megan is entitled to a bonus of $5,000, which the employer contributes to Megan’s superannuation fund. This will be an effective salary sacrifice arrangement, provided the bonus was not earned until the employer decided that Megan was entitled to it and the salary sacrifice arrangement was put in place before that event occurred. The bonus amount is not assessable income for Megan and will be treated as an employer superannuation contribution with 15% tax deducted within the fund. It counts towards the concessional contribution cap so care should be taken to not exceed the cap, especially if the quantum of the bonus is unknown.

Example 2 Ineffective salary sacrifice arrangement Igor receives a salary of $130,000 per annum. He is advised that his entitlement under his employer’s annual bonus scheme is $8,000. He is given a choice to have the bonus paid into his bank account, contributed to superannuation or receive the equivalent value of units in a unit trust that is managed by his employer. He elects to receive units in the unit trust. This will be an ineffective salary sacrifice arrangement as Igor did not forego his entitlement to the income before that entitlement arose. He merely advised his employer how the bonus entitlement should be applied. The bonus is assessable income under the Income Tax Assessment Act 1997 (ITAA97) s 6-5(4). The units are not a fringe benefit, but are treated as having been purchased by Igor. The agreement would similarly have been ineffective if he chose to have the amount contributed to superannuation. The bonus would be assessable income and the amount would be contributed as a personal non-concessional contribution and count against the non-concessional contribution cap.

¶10-060 What benefits can be salary sacrificed? The benefits that may be provided to an employee as part of their salary package can be classified into the following categories for FBT purposes: • fully taxed fringe benefits • concessionally taxed fringe benefits • exempt fringe benefits • excluded benefits. Fully taxed fringe benefits are fringe benefits for which the taxable value of the benefit for FBT purposes is the same as the monetary value of the benefit. Examples include private expenditure such as the purchase of private household furniture, payment of an employee’s private telephone bills or repayments against an employee’s home loan. This type of benefit generally provides no financial advantage to the

employee, unless the employer is entitled to FBT exemptions or rebates (¶10-620). If the employee’s marginal income tax rate plus Medicare levy is less than the top 47% rate, fully taxed fringe benefits will result in excessive tax being paid, as the FBT cost will be greater than the employee’s income tax savings.

Note The FBT rate has applied at 47% since 1 April 2014, but it temporarily increased to 49% for the 2015/16 and 2016/17 FBT years, while the Temporary Budget Repair Levy (TBRL) was in effect. The rate reduced back to 47% from 1 April 2017 when the TBRL was removed.

Concessionally taxed fringe benefits are (non-exempt) fringe benefits for which the taxable value of the benefits for FBT purposes is less than the monetary value of the benefit. The most significant example is a car fringe benefit calculated using the statutory formula method (¶3-410). Concessionally taxed fringe benefits generally provide a financial advantage for any employee on the top income tax rate. They may also be financially advantageous for employees with lower marginal income tax rates, depending on the circumstances. Potential tax savings will be further enhanced if the employer is entitled to FBT exemptions or rebates (¶10-620), or the employee makes a contribution toward the cost of the benefit to reduce its taxable value (¶10-610). Exempt fringe benefits are fringe benefits that are subject to a specific or general exemption from FBT. The most popular of these for salary packaging purposes are exempt work-related equipment and tools, such as laptops and mobile phones (¶10-520). Because there is no FBT payable and the employer will generally qualify for GST input tax credits, these will be attractive to most employees if they are planning to purchase such items for themselves. The exemption is available only where the item is used primarily for work purposes (based on intended use at the time, not actual use, but a reasonable basis for the claim is required). This category will also include benefits that are “otherwise deductible” to the employee such as interest on investment loans. Excluded benefits are benefits that are specifically excluded from the definition of fringe benefit under the FBT legislation, and therefore do not incur FBT. Common examples are employer superannuation contributions and eligible employee share schemes. Superannuation contributions are particularly popular salary packaging components due to their favourable income tax treatment and ease of administration (¶10-430) but this may diminish with the ability for employees to claim personal tax deductions from 1 July 2017. Employee share schemes are difficult to administer in a salary packaging context and are more likely to be offered as a separate program, if at all (¶10-470). Some benefit categories do not qualify for packaging Generally, the above types of benefit can be salary packaged unless there is a prohibition in the FBT legislation that effectively precludes the benefit from being the subject of a salary sacrifice arrangement. For example, (exempt) minor benefits are effectively precluded from being wholly or principally a reward for the employee’s labour (FBTAA s 58P; Taxation Ruling TR 2007/12). A similar prohibition would apply to work-related counselling (FBTAA s 58M and 136).

HOW THE TAX RULES WORK ¶10-200 The basic tax rules around income, benefits and salary packaging For salary packaging to be tax effective, the cash salary and benefits must be combined so that the overall tax is reduced. To understand how this works, you need to understand the basic way in which income tax and fringe benefits tax (FBT) operate. Calculating tax on salary and wages is straightforward. They are generally fully assessable to the employee. The tax is calculated on a sliding scale, with lower rates applying to lower incomes (¶1-055

and ¶20-010). For 2020/21, the top marginal tax rate plus Medicare levy is 47%. In contrast, the value of non-cash (fringe) benefits received by the employee is generally taxed to the employer under the FBT rules. The fringe benefits tax rate is a flat 47% from 1 April 2017. The FBT rate is applied to the taxable value of the benefits, which is “grossed-up” by a factor of 2.0802 (Type 1) or 1.8868 (Type 2) for the 2020/21 FBT year, as described at ¶3-300. (This gross-up procedure is intended to ensure parity between the tax treatment of fringe benefits and after-tax salary.) The FBT rate is applied at the top marginal tax rate plus Medicare and other levies. The history of FBT rates and gross-up rates is shown in the table below: FBT year

FBT rate

Type 1 gross-up rate

Type 2 gross-up rate

1 April 2017–31 March 2021

47%

2.0802

1.8868

1 April 2015–31 March 2017

49%

2.1463

1.9608

1 April 2014–31 March 2015

47%

2.0802

1.8868

1 April 2013–31 March 2014

46.5%

2.0647

1.8692

Note The gross-up factors were temporarily higher from 1 April 2015 to 31 March 2017 due to the impact of the Temporary Budget Repair Levy. The rate has also changed over time in line with Medicare levy changes.

Calculation of FBT liabilities (gross-up) Two different gross-up factors are used to determine the “fringe benefits taxable amount” of a fringe benefit. The gross-up factors are applied to the “taxable value” of the relevant fringe benefit. The FBT gross-up factor of 2.0802 is applied to fringe benefits that are categorised as Type 1 benefits for the 2020/21 FBT year. These are benefits for which the employer is eligible for an input tax credit under the goods and services tax (GST) regime. The FBT gross-up factor of 1.8868 is applied to fringe benefits that are categorised as Type 2 benefits for the 2020/21 FBT year. These are benefits for which the employer is not eligible for an input tax credit under the GST regime. The gross-up factors are designed to ensure that (as a general rule) the net benefit to an employee is the same whether the employee: • purchases a GST-inclusive item with after-tax salary (taxed at top marginal tax rate), or • receives the item as a fully taxed fringe benefit from the employer under a salary sacrifice agreement. In this way, an employer effectively deducts and pays FBT on the gross fringe benefit value or deducts and pays PAYG tax on the gross salary or wage. However, it should be noted that for employees on tax rates lower than the top marginal rate the FBT payable on fully taxable fringe benefits will be higher than the personal tax otherwise payable on the equivalent amount of cash salary or wages.

Exempt and concessionally taxed benefits Some benefits are exempt from FBT or are eligible for concessional FBT treatment. Special rules also apply to employer contributions to superannuation (¶10-430). In addition, certain employers are entitled to FBT exemptions or rebates up to specified limits (¶10-620). A tax-effective salary packaging strategy is generally based on accessing these exemptions and concessions.

¶10-240 Interaction of FBT and income tax The relationship between FBT and income tax can sometimes be complex, but can generally be summarised in the following rules: • In general, if an item is subject to FBT it will not be subject to income tax (This also applies to items that are specifically exempted from FBT.) • Although the marginal income tax rate for most employees is less than the 47% FBT rate, tax can still be reduced by packaging concessionally taxed fringe benefits, such as motor vehicles. The employee can increase savings further by making an after-tax contribution (recipient’s payment) toward the cost of a concessionally taxed fringe benefit (¶10-610, ¶10-710, ¶10-720). • In general, employees who are exempt from tax on their salaries will also be exempt from FBT on their fringe benefits (this may apply, for example, to certain expatriates (¶10-670)). • If an employee receives an allowance, the allowance will generally be treated as part of salary or wages and will therefore be subject to income tax. On the other hand, if the employee is reimbursed for personal expenditure, the reimbursement is generally subject to FBT. To the extent that the expenses would have been deductible if incurred by the employee, the taxable value of the benefit will be reduced (¶10-630). • The employee cannot convert salary to a fringe benefit after the entitlement has been earned by simply directing that the salary be used to provide a benefit. If this occurs, the salary will remain subject to income tax. It is therefore important that the employee’s right to receive benefits instead of salary is spelt out in an agreement with the employer before the employee has earned that remuneration (¶10-050). • Payments of FBT are tax deductible to the employer. The FBT year runs from 1 April to 31 March while the income tax year runs from 1 July to 30 June. Generally, the FBT rate is set at the top marginal tax rate but the interaction with the Temporary Budget Repair Levy until 1 July 2017 created some misalignments: • the FBT rate was set at 47% but temporarily increased to 49% for the 2015/16 and 2016/17 FBT years. • the top personal marginal tax rate is set at 45% plus 2% Medicare levy but temporarily increased with a 2% Temporary Budget Repair Levy for the 2015/16 and 2016/17 financial years. This created a misalignment for the periods 1 July 2014 to 31 March 2015 and 1 April 2017 to 30 June 2017 during which the FBT rate was 2% lower than the total top personal tax rate.

¶10-260 Valuing salary sacrificed benefits The following tables illustrate the financial impact of sacrificing salary in return for certain benefits of the types described in ¶10-060 above, assuming that the employer is not an exempt or rebatable employer (¶10-620) for FBT purposes. Table 1 illustrates the charge that would be made to an employee’s salary package (ie the amount of salary that the employee would forgo) if the employee packaged a fully taxed, concessionally taxed, exempt or excluded benefit, as described. This is based on FBT rates for the 2020/21 FBT year and

marginal tax rates for the 2020/21 financial year. Table 1: Salary forgone by packaging benefit Fully taxed benefit Benefit

$1,000 mortgage payment

Concessionally taxed benefit Car benefit: lease and running costs totalling $11,000 (car valued at $30,000 using statutory formula method)

Exempt benefit

Excluded benefit

Laptop costing $3,300 (including GST), used primarily for business

$10,000 superannuation contribution (net value is $8,500 after $1,500 tax is deducted in the fund — this assumes the additional 15% Division 293 tax for salary earners with income over $250,000 does not apply)

Taxable value of benefit

$1,000

$30,000 × 20% = $6,000

Nil

Nil

FBT calculation

$1,000 × 1.8868* × 47%

$6,000 × 2.0802** × 47%

—

—

$887

$5,866

Nil

Nil

Benefit cost

$1,000

$10,000**

$3,000**

$10,000

Charge to package

$1,887

$15,866

$3,000**

$10,000

FBT

* Assuming no input tax credit is available in respect of the mortgage. ** Assuming an input tax credit is available.

Table 2 shows the amount of before-tax salary that an employee on the top marginal tax rate (47% including Medicare levy) would have to earn to acquire the benefits mentioned in Table 1. Where the amount of charge against the salary package (Table 1) is less than the before-tax salary required to fund the benefit (Table 2), the employee would be better off packaging the benefit than buying it with after-tax income. Table 2: Pre-tax advantage from packaging Fully taxed benefit

Concessionally taxed benefit

Exempt benefit

Excluded benefit

$1,887

$20,755

$6,226 

$16,038

 $887

$9,755

$2,926*

$7,538

After-tax salary available to acquire the benefit

$1,000

$11,000

$3,300 

$8,500

Pre-tax advantage to employee

$0

$4,889

$3,226

$6,038

Percent advantage

0%

31%

108%

60%

Before-tax salary required at 47% tax Less: tax of 47%

vs salary forgone (rounded) * Assuming that the employee would not be entitled to a deduction for the laptop.

It should be noted that the above tables are illustrative only, and the advantage from packaging (if any) needs to be calculated according to the particular circumstances of the employee and the benefits concerned. For example, the results will be different for employees with different marginal tax rates, for concessionally taxed benefits with different characteristics, for benefits that are partly used for deductible purposes (¶10-630) and in circumstances where the employee contributes toward the cost of a benefit (¶10-610).

TAXABLE FRINGE BENEFITS ¶10-300 Packaging taxable fringe benefits Taxable fringe benefits may be fully taxed or concessionally taxed (¶10-060). Generally, salary packaging of taxable fringe benefits is only advantageous for benefits that are concessionally taxed or where the taxable value can be reduced. For example: • cars may be attractive salary packaging items because the statutory formula method of valuing car fringe benefits reduces the taxable value to an amount lower than the actual cost (or the logbook method can also be effective if the business use is high) • an exempt or rebatable employer (¶10-620) is able to provide attractive salary packaging opportunities because the taxable value of benefits that the employer provides (within specified limits) is effectively eliminated or reduced by the employer’s FBT exemption or rebate • the “otherwise deductible” rule (¶10-630) may provide timing advantages where expenditure that the employee would otherwise have been eligible to deduct for income tax purposes is instead paid by the employer. The following taxable benefits are discussed in this subchapter: • cars (motor vehicles) (¶10-310) • car parking (¶10-320) • loans (¶10-340) • living-away-from-home allowances (LAFHAs) (¶10-350) • meal entertainment (¶10-370).

¶10-310 Cars (motor vehicles) as fringe benefits Motor vehicles can be an effective component of salary packaging for a number of reasons, including: • employees receive vehicle financing assistance • employers may be able to provide vehicles at a lower cost due to fleet discounts • cars are eligible for concessional FBT treatment under the statutory formula method of valuation (¶3410). The FBT value of a car can be determined under the statutory formula or operating cost method. In general, where there is minimal business use, the statutory formula will be used to value the car for FBT purposes because it will typically produce a lower taxable value. On the other hand, where there is high

business use, typically the operating cost (logbook) method may produce a lower taxable value. There is no set break-even point at which the operating cost method produces a lower taxable value for FBT purposes. However, it often falls between 70%–80% business use of the car, depending on the level of car expenses. A flat statutory rate of 20% applies to all car package arrangements since 1 April 2014. Prior to this, different rates applied depending on the annual mileage for the car. Employees can receive the benefit of any GST input tax credit that the employer receives in relation to the cost of the car and/or the operating costs of the car (but the Type 1 gross-up factor will generally apply: ¶10-200). Example 1 No business use Loren receives a salary package of $105,000 from her employer, Orbit Pty Ltd. The agreement between Orbit and Loren is that the package total includes any employer superannuation obligations. This example shows the benefit to Loren in her take-home pay by packaging a car, compared with not packaging a car.

Assumptions Cost of car Kilometres travelled Statutory fraction Business percentage

$30,000 20,000 0.20 Nil

Taxable value

$6,000

Gross-up factor

2.0802

Fringe benefits taxable amount FBT payable @ 47%

$12,481 $5,866

Note: Since Loren’s car is leased, the gross-up factor is determined by whether or not GST is included in the lease payments. It has been assumed that GST is included in all the lease payments and that Orbit is entitled to input tax credits. Therefore, the gross-up factor of 2.0802 has been used. The standard 20% statutory rate applies regardless of kilometres travelled. Car operating expenses per annum

Invoiced amount (GST inclusive)

Charge to package (2020/21)

Lease

$7,920

$7,200

Registration

$1,000

 $1,000*

Insurance

$1,650

$1,500

Repairs

$1,430

$1,300

Fuel

$3,300

$3,000

Total annual operating expenses

$15,300

$14,000

* As there is no GST on car registration, the charge to the package is the full price of the registration. Note: The cost of the car operating expenses to the employer after an input tax credit of $1,300 is $14,000. Therefore, the charge to Loren’s package for car operating expenses is $14,000. The make-up of Loren’s package is:

Car operating expenses FBT on the car Salary

$14,000 $5,866 $77,748

Superannuation — SG (9.5%) Total salary package

$7,386 $105,000

Comparison of Loren’s take-home pay amounts

Salary, SG-super and no car: Salary

$95,890

Less: tax and Medicare levy at 2020/21 rates (including offsets)

$23,991

After-tax salary

$71,899

Less: car operating expenses

$15,300

Net take-home pay

$56,599

Salary, SG-super and employer-provided car: Adjusted salary

$77,748

Less: tax and Medicare levy at 2020/21 rates (including offsets)

$17,290

New net take-home pay

$60,458

Loren is better off by $3,859 ($60,458 − $56,599)

Reconciliation Reduction in personal income tax

$6,701

Savings on GST

$1,300

Reduction in employer SG contributions

$1,724

Total savings

$9,725

Less: FBT cost on car

$5,866

Loren’s cash advantage

$3,859

Example 2 High business use In this example we retain all the assumptions about Loren’s income and car running expenses. However, we now assume that the business use of Loren’s car is 80%. The “operating cost” method is used to calculate the FBT payable, as this method produces a lower FBT payable where there is a high level of business use. FBT calculations:

Taxable value (operating costs $15,300 × 20%)

$3,060

Gross-up factor

2.0802

Fringe benefits taxable amount

$6,365

FBT payable @ 47%

$2,992

Note: The operating costs in the taxable value calculation are the GST-inclusive amounts. The make-up of Loren’s package would now be:

Car operating expenses

$14,000

FBT on car Salary Superannuation — SG (9.5%) Total salary package

$2,992 $80,373 $7,635 $105,000

Comparison of Loren’s take-home pay amounts Situation 1 Salary

$95,890

Less: tax and Medicare levy at 2020/21 rates (including offsets)

$19,326

After-tax salary

$76,564

Less: Car operating expenses

$15,300

Net take-home pay

$61,264

Note: – Loren’s employer will contribute $9,110 into the employee’s superannuation fund, which will be subject to 15% contributions tax of $1,366. – The taxable income amount is derived after deducting an amount for business use car expenses of $12,240 ($15,300 × 80%).

Situation 2 Adjusted salary

$80,373

Less: tax and Medicare levy at 2020/21 rates (including offsets)

$18,196

New net take-home pay

$62,177

Loren is better off by $913 ($62,177 − $61,264)

Reconciliation Reduction in personal income tax

$1,131

Savings on GST

$1,300

Reduction in employer SG

$1,475

Total savings

$3,906

Less: FBT cost on car

$2,992

Loren’s cash advantage

$914*

* Difference due to rounding

Depreciation limits An upper limit applies to the cost of a car that can be used to calculate depreciation deductions. A car is defined as a vehicle designed to carry a load of less than one tonne and less than nine passengers. Other vehicles are not subject to this limit. The car limit for 2020/21 is $59,136. The limit that applies in the first year that the car was used for business purposes is the limit that applies. If a car is leased (other than genuine short-term hire arrangements) the lease is treated as a loan transaction so that the lessee (employer) is treated as the owner of the car. The lessee is entitled to

deductions for depreciation (subject to the car limit) and for the imputed interest component (but not the capital component) of the lease payments. A car that is purchased for more than the depreciation limit has a maximum GST credit equal to 1/11th of the limit. This limit reduces the tax benefits that would otherwise result from provision of a car, but higher value cars can still be valuable package items. The FBT treatment of higher value cars is the same as for other cars, but an additional amount needs to be charged to the employee’s salary package to reflect the tax cost of the partial non-deductibility. Novated leases Cars can be provided in various ways. The employer may own the vehicle or lease it, or the employee may own the vehicle and be paid an allowance. Alternatively, the car can be leased by the employee, with the lease being novated to the employer. The novated lease method has become more popular in recent years because of factors such as: • the desire to shift responsibility for the car back to the employee when the employee leaves • the desire to save on income tax by substituting the provision of a car fringe benefit for salary • the higher taxation of allowances in comparison to the concessional treatment of car benefits. The steps in implementing a novated lease are typically as follows: Step 1: the employee enters into a car finance lease with a finance provider. Step 2: the employee, employer and finance provider enter into a novation agreement that has the effect of transferring all the rights and obligations of the car finance lease, to the employer. Step 3: the employer is obligated to make the lease payments to the finance provider. Step 4: upon completion of the lease payments or earlier termination of employment, all the remaining rights and obligations of the employer will be novated to the employee. Example 3 Novated lease This example illustrates the effect of a novated lease, using the statutory formula method of valuing the taxable benefit. In effect the taxation impact of using a novated lease is the same as if the employer had provided the car via a lease directly with a finance company.

Assumptions Car base value Kilometres travelled pa

$33,000 20,000

Statutory fraction

0.20

FBT rate (2020/21 FBT year)

47%

Gross-up factor

Employee’s marginal tax rate (incl Medicare)

2.0802

47%

Note: (1) The car base value is a GST-inclusive amount. (2) Because the car is leased and GST input tax credits are allowable, the car fringe benefit is a Type 1 benefit and the gross-up rate is 2.0802 for the 2020/21 FBT year. (3) Legislation applies a standard 20% statutory rate regardless of kilometres travelled.

FBT calculation

$33,000 × 20% × 2.0802 × 47% =

$6,453

Annual running costs Lease Registration (no GST)

$7,920 $600

Insurance

$1,100

Petrol and oil

$3,300

Maintenance

$1,100

Road service

 $55

Total running costs (incl GST)

$14,075

Amount charged to package ($13,475 × 10/11 + $600)

$12,850

Total charge to package including FBT

$19,303

Advantage to employee Amount of pre-tax salary needed to cover motor running costs of $14,075, ie $14,075 ÷ (1 − 47%)

$26,557

Less: Actual charge to package for car running costs and FBT Advantage to employee ($7,254 salary − $3,410 tax)

$19,303 $3,844

Reconciliation Savings in personal income tax ($26,557 − $7,254) × 47%

$9,072

Savings in GST ($13,475 ÷ 11)

$1,225

Total savings

$10,297

Less: FBT cost

$6,453

Net savings to employee

$3,844

Note: FBT rate is 47% for 2020/21 FBT year.

For a novated lease agreement to be effective, the lease must be fully novated in accordance with Taxation Ruling TR 1999/15. Associate leases It is possible to have a situation where the spouse (or other associate) of the employee owns a car and leases it under an operating lease to the employer for provision to the employee (or other associate). This type of arrangement is called an associate lease. Under this arrangement, all expenses are included in the total employment cost (¶10-040) and the lease payments are assessable to the associate, who can claim depreciation and any interest costs as deductions. This may be a particularly appropriate arrangement for: • second and other vehicles • lower-salaried employees (see case study one at ¶10-710 for a worked example) • small businesses where the provision of a car would not normally be contemplated. Many employers may not be willing to add to their existing administration burden by managing the expenses of additional benefit cars. An alternative is for the associate to pay all running costs and for this

amount to be reflected in an increase in the lease payment to the associate.

¶10-320 Tax consequences of providing car parking Car parking benefits are often a benefit to city-based employees where the cost of parking is considerable. The benefits are subject to FBT if there is a commercial car parking station located within a one-kilometre radius of the employer (where the car will be parked) that charges a daily parking fee above $9.15 (FBT year ending 31 March 2021). A shopping centre car park is not a commercial car parking station for this purpose. Also, an FBT exemption applies to car parking benefits provided by employers with a total income in the previous year of less than $10m. The car must not be parked at a commercial parking station and the employer must not be a public company or government body. This exemption also provides opportunities for tax-effective packaging. Example 1 Car parking fringe benefit There are two commercial parking stations within a 1-km radius of Francesca’s workplace. The lowest all-day parking fee for one is $11.00, and for the other is $8.00. Both parking stations are nearly 0.8 km from Francesca’s work, are uncovered and are usually full. Francesca’s employer has a limited number of car parking spaces in the basement of its business premises, with a market value of $12 per day, which it makes available to employees for $10 a day. Francesca’s employer is not eligible for the small business car parking exemption. Francesca decides to park in her employer’s parking facility and to salary sacrifice the parking fees, less an employee contribution of $8.00 per day. Francesca’s marginal tax rate is 47% including Medicare. The employer uses the commercial car parking station method for determining the daily taxable value for FBT purposes. Using that method, the daily taxable value would be $8.00 per day (Taxation Ruling TR 96/26). The employer also uses the statutory formula method for determining the FBT taxable value for the year (¶3-420). The statutory formula method assumes 228 working days per year. By making an employee contribution of $8.00 per day, Francesca reduces the taxable value to nil, so that there is no FBT on the car parking benefit.

(1)

Annual cost without packaging (228 days × $10)

$2,280

Annual cost after packaging: (2)

Employee contribution (228 days × $8.00)

$1,824

(3)

Salary sacrifice amount: (1) − (2)

(4)

FBT: (13) below

(5)

Reduction in pre-tax salary: (3) + (4)

$456

(6)

Less: employee tax saving at 47%

$214

(7)

Reduction in after-tax salary

(8)

Annual after-tax cost to employee: (2) + (7)

(9)

After-tax savings from packaging: (1) − (8)

$456 Nil

$242 $2,066

$214

FBT calculation: (10)

Taxable value before contribution (228 days × $8.00)

$1,824

(11)

Less: employee contribution

$1,824

(12)

Taxable value

Nil

(13)

FBT on car parking benefit

Nil

Example 2 Car parking small business exemption Within a 1-km radius of Dominic’s workplace, the cheapest commercial parking station charges $11.00 per day. Dominic’s employer has a few car parking spaces on its business premises. Because employee demand significantly exceeds the number of spaces available, the employer only allocates spaces to employees who agree to pay $2,000 per year by payroll deduction or by salary sacrifice. Dominic’s employer has a turnover of less than $10m and is eligible for the small business car parking exemption. Accordingly, there will be no FBT on the car parking benefits. Dominic decides to park in his employer’s car park, and salary sacrifice $2,000 for the privilege. Dominic’s marginal tax rate is 47% including Medicare.

(1)

Annual employee cost via payroll deduction

$2,000

Annual cost via salary sacrifice: (2)

Salary sacrifice amount

(3)

Less: tax reduction at 47%

(4)

Reduction in after-tax salary

(5)

After-tax savings from packaging: (1) − (4)

$2,000 $940 $1,060

$940

Note: FBT rate used in these examples is 47% for 2020/21 FBT year.

¶10-340 Income tax and FBT treatment of loans The combined effect of the FBT and income tax treatment of loans means that there are limited tax advantages from providing discounted loans to employees of employers that are taxable entities. The advantages lie mainly in convenience to the employee. Because of the costs of administration, there is a tendency for loans only to be offered: • to key employees, or • by employers in the business of money-lending. A benchmark interest rate is used to determine the taxable value of a loan provided as part of a salary sacrifice arrangement. For the 2020/21 FBT year, this rate is 4.80%. Example Anastacia’s employer lends her $40,000 on 1 April 2020. It is an interest-only loan at the rate of 4% for four years. At the end of this four-year period, the loan must be repaid. During the first year, actual interest is $1,600 ($40,000 × 4%). The notional interest is $1,920 ($40,000 × 4.80%). For FBT purposes this creates a taxable value of $320 ($1,920 − $1,600).

Provided the relevant concessional caps are not breached (refer to ¶10-620): • hospitals or public benevolent institutions can provide interest-free or discounted loans with no FBT applicable, and • rebatable employers can provide interest-free or discounted loans with reduced FBT. These concessional caps were temporarily increased from 1 April 2015 to 31 March 2017. This was the period when the FBT rate was increased to include the impact of the Temporary Budget Repair Levy.

¶10-350 Living-away-from-home allowance

A living-away-from-home allowance (LAFHA) is paid to an employee to compensate for additional expenses or disadvantages if the employee is required to temporarily live away from their usual place of residence. This is different to a travelling allowance, which is compensation for costs incurred in the normal course of business. From 1 October 2012, the taxable value of LAFHA (ie the allowance paid) is included in the employee’s assessable income and as such is not subject to FBT unless exempt under the 12-month exemption rule or fly-in fly-out (FIFO)/drive-in drive-out (DIDO) rules. 12-month exemption A 12-month exemption applies for eligible employees for amounts paid for food and accommodation within reasonable limits. During this period, the amounts are tax-free to the employee and do not constitute a taxable fringe benefit. To be eligible, the employee must have been at the work location for less than 12 months and maintain a home in Australia which is available for personal use at all times. An exemption applies for reasonable accommodation costs. The employee needs to maintain evidence to substantiate the claim. An exemption applies for reasonable food and drink costs less a “normal” (statutory) food cost. The reasonable amounts are provided by the ATO in a Tax Determination each year and depend on the number of people in the family for which they are being claimed. For the FBT year commencing 1 April 2020, the reasonable amounts are specified in Taxation Determination TD 2020/4. The statutory amounts are set out in the Fringe Benefits Assessment Act 1986 at $42 per week for adults and $21 per week for children. Employees need to substantiate expenses if they want to claim higher amounts. The employee must provide an appropriate declaration to the employer. This is generally required before lodgment of the employer’s FBT return, and at least by 21 May following the relevant FBT year. FIFO and DIDO Fly-in fly-out (FIFO) or drive-in drive-out (DIDO) employees do not have to maintain a home in Australia to claim the exemptions. They are also not limited to a 12-month period. Employees still need to substantiate expenses incurred for accommodation and food or drink amounts that exceed the ATO limits. A declaration needs to be provided to the employer.

¶10-370 Meal entertainment provided to employees Meal entertainment benefits provided to an employee are generally subject to FBT (¶3-200). If the employer elects to use the 50/50 split method to calculate the portion of meal entertainment that will be subject to FBT, the “meal entertainment fringe benefit” provided would be 50% of the price paid for the relevant meal entertainment. This often does not provide any advantage to the employee under current FBT rules. Example

Anthony’s total package is $130,000, comprising: Salary

$118,000

Superannuation contribution Basic salary package

$12,000 $130,000

Anthony negotiates with his employer, True Blue Discount Store, to package private entertainment. He decides that no adjustment is to be made to the level of his employer’s superannuation contribution amount of $12,000. In the current year Anthony’s meal entertainment amounts to $17,050:

Regular meal entertainment

$5,500

Daughter’s wedding breakfast

$11,550

Total meal entertainment

$17,050*

* includes GST

True Blue Discount Store has elected to use the 50/50 split method and therefore the “meal entertainment fringe benefit” is $8,525. The remaining $8,525 is non-deductible entertainment to True Blue. No GST input tax credit is available on the non-deductible portion. The fringe benefit is a Type 1 benefit with a gross-up factor of 2.0802 (for 2020/21 FBT year) and therefore the FBT cost applicable to this benefit is $8,335: Taxable value

$8,525

Grossed-up amount ($8,525 × 2.0802)

$17,734

FBT $17,734 × 47%

$8,335

The new make-up of Anthony’s package of $130,000 is: Meal entertainment (tax-deductible portion) ($17,050 × 50% × 10/11) Meal entertainment (tax non-deductible portion) ($17,050 × 50% × 1/0.70*) FBT

$7,750 $12,179 $8,335

Superannuation

$12,000

Adjusted salary

$89,736

Adjusted salary package

$130,000

Note: – * Assumes company tax rate of 30%. Small companies may pay a lower rate of tax. – No input tax credits are available regarding non-deductible meal entertainment. – FBT rate is 47% for 2020/21 FBT year. The after-tax cost to the employer of Anthony’s package is $91,000 ($130,000 × 70%). Analysis

Details

Cost

Cost after tax

Charge to package

Meals (deductible)

$7,750

$5,425

$7,750

Meals (non-deductible) ($17,050 × 50% × 1/0.70)

$8,525

$8,525

$12,179

FBT

$8,335

$5,835

$8,335

Superannuation

$12,000

$8,400

$12,000

Adjusted salary

$89,736

$62,815

$89,736

$91,000

$130,000

Total package Note:

All “charges to package” are pre-tax to employer, therefore all “cost after-tax” items need to be grossed-up. Comparison of Anthony’s take-home pay amount

Before packaging of meal entertainment Salary Less: tax and Medicare levy at 2020/21 rates (incl offsets)

$118,000 $33,277

After-tax salary

$84,723

Less: meal entertainment expenses

$17,050

Net take-home pay

$67,673

After packaging of meal entertainment Adjusted salary

$89,736

Less: tax and Medicare levy at 2020/21 rates (incl offsets)

$21,426

New net take-home pay

$68,310

Anthony is better off by $637 ($68,310 − $67,673) Reconciliation

Personal income tax reduction ($33,277 − $21,426) Savings on GST

$11,851  $775

$12,626

Less: FBT

$8,335

Non-deductible meal differential ($12,179 − $8,525)

$3,654

Net benefit

$637

EXCLUDED FROM FBT RULES ¶10-400 Employer arrangements excluded from FBT Some employer arrangements are expressly excluded from FBT and are instead covered under other taxation rules. As such, they may provide significant tax advantages. The most common of these arrangements is salary sacrifice into superannuation (¶10-430 and see also ¶4-215), as it is generally easy to administer through the employer’s payroll system and the financial benefits can be readily calculated. Benefits provided under an approved employee share scheme are also excluded from FBT. They are more complex and so are generally administered separately from any salary packaging program (¶10470).

¶10-430 Salary sacrifice into superannuation Superannuation is a very common component of salary packages and provides significant potential tax savings for employees. However, superannuation is primarily a retirement savings vehicle and contributions on behalf of an employee generally cannot be accessed by the employee until retirement. This concept is called preservation (¶15-400). The value of superannuation contributions to the employee is essentially dependent on the employee’s retirement strategy. Employer superannuation contributions to an employee’s complying superannuation fund are not subject to FBT and are not included in the employee’s taxable income. This includes in-specie contributions made after 1 July 2007. However, employer superannuation contributions for the employee’s spouse or other associates are subject to FBT. Employer contributions are taxed by the complying superannuation fund upon receipt, but at a concessional rate of 15% (¶4-320). An additional 15% tax will apply to individuals with “income” over $250,000 in the year (Division 293 tax) — this threshold was reduced from $300,000 on 1 July 2017.

Example An employer offers employees the ability to sacrifice $5,000 of their salary into superannuation, in addition to the SG contributions that would normally be received on full cash salary. The effect for an employee on a gross package of $97,000 is as follows:

No salary sacrifice

Salary sacrifice

Salary

$88,584

$83,584

SG (9.5% of original cash salary)

$8,416

$8,416

 —

$5,000

$97,000

$97,000

Tax and Medicare levy (2020/21 rates incl offsets)

$20,965

$19,304

Contributions tax (15%)

$1,262

$2,012

Net value of package to employee

$74,773

$76,684

Salary sacrifice superannuation contribution Gross package before tax Less taxes:

Impact of concessional contributions cap The ability to salary sacrifice tax-effectively to superannuation is limited by the concessional contributions cap. This cap includes all employer contributions (SG, salary sacrifice and voluntary), as well as personal deductible contributions. The concessional contribution cap in 2020/21 financial year is $25,000. Clients with a total superannuation balance under $500,000 will be able to rollover any unused cap on a five-year rolling basis starting with any unused amounts from the 2018/19 financial year. This allows a potentially higher cap in an eligible financial year. Salary sacrifice contributions made from 1 July 2013, that exceed the concessional contributions cap, will be taxed at the individual's marginal tax rate (less the 15% tax deducted in the fund) plus an interest rate penalty (excess contributions charge) to account for the delay in tax collection. If an election is made to withdraw the excess amount from superannuation, it will not also count in the non-concessional contribution cap.

Note From 1 July 2017, anyone who is eligible to contribute to superannuation can choose to claim tax deductions for personal superannuation contributions. This might increasingly reduce the focus on salary sacrifice and clients might choose to take the greater flexibility and control offered with personal tax deductions.

From 1 January 2020, employers can no longer use salary sacrificed superannuation contributions to cover compulsory SG contributions. This eliminates the possibility of the total remuneration package reducing due to salary sacrifice into superannuation. Superannuation as a financial planning strategy is discussed in Chapter 15.

¶10-470 Employee share schemes Benefits under certain types of employee share schemes are excluded from FBT rules and while captured under income tax rules, the benefits may be eligible for income tax concessions. Under these schemes

the employee purchases shares at a discount or under salary sacrifice arrangements or the shares may be allocated in lieu of a cash bonus. Restrictions apply to when the shares can be disposed of, so shares are held in trust until a particular vesting point. Share purchases under an employee share scheme are assessable income unless one of the following exemptions or deferral provisions applies: • exemption scheme — a person who has adjusted taxable income of less than $180,000 will receive a $1,000 tax exemption. In this case, the first $1,000 of the discount is excluded from assessable income. To receive the exemption, there can be no risk of forfeiture* and the share scheme needs to be offered to 75% of permanent employees with at least three years of service. The shares cannot be sold within the first three years unless employment is terminated. • deferral scheme — if there is a real risk of forfeiture of the shares, tax on the discount will be deferred for up to seven years. (A “real risk of forfeiture” applies where there is a genuine chance that the shares may not vest in the person’s name, for example, due to the need to meet a performance hurdle or minimum employment period.) The discount becomes assessable income at the earlier of the date when the employee is able to choose to sell the shares, employment is terminated or seven years. The share scheme needs to be offered to 75% of permanent employees with at least three years of service. • salary sacrifice deferral — employees allocated shares under a salary sacrifice arrangement will have tax deferred on the sacrificed amount provided the sacrificed amount does not exceed $5,000 and is equal to the market value of the shares allocated. The share plan rules need to specifically state that the provisions in Div 83A of ITAA97 apply. The market value of the allocated shares becomes assessable income at the earlier of the date when the employee is able to choose to sell the shares, employment is terminated or seven years. Note that a “dividend equivalent payment” paid by a trustee under an employee share scheme is assessable to an employee as ordinary income where the payment has a sufficient connection with the employee’s employment, according to Taxation Determination TD 2017/26, which applies to dividend equivalent payments paid under the terms and conditions attached to ESS interests granted on or after 1 January 2018 (see ¶1-265).

EXEMPT FRINGE BENEFITS ¶10-500 Packaging exempt fringe benefits Exempt benefits are beneficial to an employee’s salary package because no FBT is payable by the employer, so the employee’s salary package is debited with only the cost of the benefit provided. However, not all exempt benefits can be salary packaged due to a prohibition on some exempt benefits (eg minor benefits and work-related counselling) from being provided as a reward for services. Other categories of exempt benefit that are generally not included in a salary sacrifice arrangement are those benefits that are necessary for the employee to carry out their employment duties. Examples include the exemptions for computer software, newspaper and periodicals and some taxi travel. The following paragraphs consider some exempt benefits that may be salary sacrificed.

¶10-520 Laptops and work-related equipment Useful FBT exemptions (¶3-600) apply to: • mobile phones or car phones used primarily for the job • computer software used for the job • protective clothing required for the job

• a briefcase, tools of trade, electronic diary or personal digital assistant (PDA), notebook computer, hand-held computer or similar portable computer, and a portable printer designed for use with a portable computer. Where it is not possible to identify the primary function of a combined PDA/mobile phone, it may be treated as either a PDA or a mobile phone. The portable electronic device exemption applies only for items that are used primarily for work purposes and is generally limited to one item of each type per employee per year. From 1 April 2016, small businesses are allowed exemptions for more than one work-related portable electronic device in an FBT year (even if substantially identical functions). From 1 April 2017, the turnover threshold to be considered a small business was increased from under $2m to $10m. Example Laptop On 1 July 2020, Mayumi’s employer gives her full ownership of a laptop under a salary sacrifice arrangement. She uses the laptop 100% for work. The benefit is fully FBT exempt and the full GST input tax credit is available. If she bought the laptop herself, Mayumi could deduct $2,200 depreciation in the first year for the 100% work use. Mayumi’s base salary is $90,000, plus a fixed superannuation contribution of 10% of base salary (unaffected by salary sacrifice). The superannuation is ignored in the example below, as the employer will pay the same with or without packaging.

Salary

Without packaging

With packaging

$90,000

$87,000

Laptop

$3,300

Less: input tax credit Total excluding superannuation

$300 $90,000

$90,000

$2,200

0

Taxable income

$87,800

$87,000

Less: tax and Medicare levy at 2020/21 rates (incl offsets)

$20,659

$20,347

Depreciation deduction

Less: purchase of laptop Cash benefit after laptop purchase

Mayumi is better off by

$3,300 $66,041

$66,653

$612

Reconciliation: Reduced income tax and Medicare levy

$312

GST savings

$300

Total cash advantage

$612

¶10-530 Frequent flyer benefits Benefits received by an employee from membership of a frequent flyer program are not subject to FBT or income tax. This means that if the employee is a member of a program, business travel paid for by the employer may effectively entitle the employee to free or discounted non-business travel. Because of its indeterminate nature, it may not be appropriate to formally include this in a salary package, but the potential benefits are nevertheless significant.

Where a high volume of business expenses is used to generate rewards for an employee, there may be potential FBT or income tax consequences. See Practice Statement PS LA 2004/4 (GA).

¶10-540 In-house child care Child care provided to an employee’s child in a child care facility that is located on the employer’s business premises is an exempt benefit. The notional value of the child care can be salary packaged by the employee, with a resulting savings in income tax. However, the significance of the in-house child care FBT exemption as a salary packaging strategy has been largely eliminated by the child care subsidies that are now available through the federal government’s Child Care Subsidy. This subsidy is available only in relation to costs incurred by the family, not the employer. Accordingly, the relative value of tax benefits versus child care subsidies needs to be examined before opting into an in-house child care salary sacrifice arrangement. In the Esso case, it was held that the FBT child care exemption for facilities provided on the “business premises” of an employer applied to premises leased jointly by the taxpayer and two other companies solely for the purpose of providing child care facilities to employees. In other words, an employer need not have exclusive possession of child care premises for the premises to qualify as the employer’s “business premises” (see Taxation Ruling TR 2000/4).

¶10-550 Awards for long service Long service award benefits typically take the form of a property fringe benefit (eg a watch with a predetermined value set by the employer) and are exempt up to $1,000 for 15 years of service plus $100 for each additional year if certain conditions are met. However, an employee could make an employee contribution to reduce the notional taxable value of a more expensive gift down to the exemption threshold. Also, the ATO accepts that in some circumstances an employee may use salary packaging to receive a long service award of greater value than the employer would otherwise have provided, but less than the threshold amount (minutes of National Tax Liaison Group FBT Sub-committee meeting, 17 November 2005). Example ABC Pty Ltd service recognition policy states that after 15 years of service each employee will be entitled to receive a watch with a value of $250. However, company policy permits employees to salary package an amount so that a higher value watch can be awarded. Accordingly, an employee salary packages an amount of $750 and a watch with a notional taxable value of $1,000 is provided by ABC Pty Ltd. No FBT will be payable.

¶10-570 Other exempt benefits Changes were made to some of the previously FBT-exempt benefits from 1 April 2014. In particular, the previous $1,000 exemption on in-house benefits no longer applies. These benefits are now valued at market value. Other restricted FBT exemptions that still provide some scope for packaging include: • priority access to child care • taxi travel to or from the workplace • membership or subscription fees, eg subscriptions to trade or professional journals, entitlement to use a corporate credit card, entitlement to use an airport lounge membership • exempt property benefits (¶3-200) • minor benefits (less than $300 as GST-inclusive value) that are provided on an infrequent and

irregular basis may be exempt in certain situations. Exempt property benefits A property benefit that is provided by the recipient’s employer on its business premises and consumed by the employee on the same working day is exempt from FBT under FBTAA s 41. In recent years, employers and employees have entered into salary sacrifice arrangements under which the employee receives property benefits consisting of food that is exempt under s 41 (see, for example, Class Rulings CR 2005/89 and CR 2008/23). However, since 1 April 2014, this exemption cannot be applied to meals.

REDUCTIONS IN FBT ¶10-600 Increased savings from reduced FBT There are a number of circumstances in which the FBT on some fringe benefits can be reduced, either directly or by a reduction in taxable value. This similarly reduces the amount debited to the employee’s salary package. For some benefits the reduction may be 100% (eg where the employer is exempt or the otherwise deductible rule is applied), and therefore the cash saving for the employee is the same as if an exempt benefit (¶10-500) had been provided. The following paragraphs consider some of the circumstances in which the FBT on a benefit may be reduced.

¶10-610 Employee contributions reduce FBT FBT on a benefit will be reduced if the employee makes a contribution (recipient’s payment) toward the cost of the benefit (¶3-410 and ¶3-550). For every dollar that the employee contributes, the taxable value of the benefit is reduced by a dollar. If the contribution equals the taxable value, FBT will be reduced to nil. This can be an effective strategy for providing concessionally taxed benefits to employees who are on a marginal tax rate lower than the FBT rate of 47% (for the 2020/21 FBT year). (For example, in case studies one and two at ¶10-710, the employee makes substantial savings by contributing to the cost of her car as shown in case study two, when compared to making no contribution in case study one.) However, employee contributions may have GST implications for the employer. Employers will be required to account for GST amounting to 1/11th of an employee’s cash contribution. On the other hand, non-cash contributions by employees, such as the payment by employees of fuel expenses in respect of an employer-provided car benefit, will not be subject to GST in the hands of the employer (¶3-950). Example 1 Katherine is provided with a car fringe benefit by her employer, Orbit Pty Ltd, which is registered for GST purposes. During the period 1 April 2020 to 31 March 2021, Katherine makes a cash contribution of $4,400 directly to her employer towards the running costs of the car. – Orbit will have to remit $400 (1/11th of $4,400) of that contribution in respect of GST. – Orbit can deduct the full $4,400 of the contribution when calculating the taxable value of the car for FBT purposes.

Example 2 Thomas is provided with a car fringe benefit by his employer, Blue Gum Developments, which is registered for GST purposes. Thomas makes a contribution towards the running costs of the car by paying for the petrol, oil and servicing. During the period from 1 April 2020 to 31 March 2021, the total of these costs amounted to $2,900. In these circumstances the ATO advises that Thomas’ contribution is not considered to be a contribution for the supply of the car fringe benefit for GST purposes, but instead would have been a contribution for the supply of those items or services by a third party, namely the service station (Taxation Ruling TR 2001/2). Therefore: – Blue Gum will not account to the ATO for GST in respect of Thomas’ purchases.

– Blue Gum can deduct the full $2,900 of the non-cash contribution when calculating the taxable value. – If the cost of Thomas’ car is $30,000 and the statutory fraction is 0.20, the taxable value is calculated as follows:

$30,000 × 0.20

=

$6,000

Less: employee contribution

=

$2,900

Taxable value

=

$3,100

For other worked examples involving employee contributions (recipient payments), see Example 1 at ¶10320 and case study two at ¶10-720.

¶10-620 Exempt and rebatable employers Certain types of non-profit employers (eg charities, educational institutions) are either exempt from FBT (¶3-600) or entitled to a 47% rebate (reduction) on their FBT liability (¶3-650) in the 2020/21 FBT year (a different rebate level applied in prior years due to the effect of Medicare and Temporary Budget Repair Levy as shown in the table below). This enables eligible employers to provide more favourable salary packaging opportunities to their employees, given they often have limited budgets. For some exempt employers the FBT exemption is unlimited. However, the FBT exemption available to charitable institutions and certain other non-profit organisations is limited to certain excluded benefits and benefits having a grossed-up value (for the 2020/21 FBT year) of: • $17,000 for an employee of a hospital or public ambulance service • $30,000 for an employee of a health promotion charity or a non-hospital public benevolent institution. To be eligible for the exemption, these entities must be specifically endorsed by the Commissioner. The FBT rebate (¶3-650) available to rebatable employers for the 2020/21 FBT year is limited to benefits having a grossed-up value of $30,000 for each employee. The changes in these FBT concessions are shown in the table below. Employer

2014/15 FBT year

2015/16 and 2016/17 FBT years

2017/18 to 2020/21 FBT years

Public benevolent FBT exemption capped institution (not hospitals) at $30,000 and health promotion charities

FBT exemption capped at $31,177

FBT exemption capped at $30,000

Hospitals (public and non-profit) and public ambulance services

FBT exemption capped at $17,667

FBT exemption capped at $17,000

FBT rebate of 49%, capped at $31,177

FBT rebate of 47%, capped at $30,000

FBT exemption capped at $17,000

Rebatable employers — FBT rebate of 48%, certain registered capped at $30,000 charities, nongovernment and nonprofit organisations

The above limits apply on an employer by employer basis. This means, for example, that a person who works part-time for two different exempt employers will be eligible for the full exemption limit from each employer. The full exemption per employee is available even if the employee was employed for only part of the FBT year by that employer. Any amount above this limit for an individual employee is subject to normal FBT treatment, ie it will not be

exempt or entitled to the rebate. Example 1 Rebatable employer Melinda is employed by a rebatable employer. She has a salary package of $105,000 plus a fixed amount of superannuation. She arranges for her employer to pay home mortgage payments on her behalf, amounting to $14,400 annually. The grossed-up taxable value of these payments is $27,170. As this is below the $30,000 limit, the entire amount is eligible for the 47% FBT rebate.

Salary

Without packaging

With packaging

$105,000

$83,832

Mortgage payments

$14,400

FBT payable (see below) Total package, excluding superannuation

$6,768 $105,000

$105,000

Less: tax and Medicare levy at 2020/21 rates (incl offsets)

$27,817

$19,389

After-tax salary

$77,183

$64,443

Less: mortgage payments

$14,400

Net cash remaining

$62,783

Melinda is better off by

$64,443

$1,660

Reconciliation: Income tax and Medicare savings

$8,428

Less: FBT (2020/21)

$6,768

Net savings

$1,660

FBT calculation: Taxable value

$14,400

Gross-up factor

1.8868

Taxable amount

$27,170

FBT rate (2020/21) FBT before rebate

47% $12,770

Less: FBT rebate (47%)

$6,002

FBT payable

$6,768

Example 2 Exempt employer Roberto is employed by a public hospital that is exempt from FBT up to the grossed-up limit of $17,000 per employee. Roberto arranges with the hospital to pay home mortgage payments on his behalf, amounting to $9,000 per year. Under the arrangement with the hospital, there is no change in Roberto’s superannuation entitlements. Roberto’s base salary is $95,000 per year. The grossed-up mortgage payments are less than the limit and are therefore exempt from FBT.

Salary

Without packaging

With packaging

$95,000

$86,000

Mortgage payments

$9,000

FBT payable (see below)

Nil

Total package, excluding superannuation

$95,000

$95,000

Less: tax and Medicare levy at 2020/21 rates (incl offsets)

$23,617

$20,137

After-tax salary

$71,383

$65,863

$9,000

—

$62,383

$65,863

Less: mortgage payments Net cash remaining

Roberto is better off by

$3,480

Reconciliation: Income tax and Medicare savings Less: FBT (2020/21) Net savings

$3,480 Nil $3,480

FBT calculation: Taxable value

$9,000

Gross-up factor

1.8868

Taxable amount

$16,981

Less: exempt amount (limit $17,000)

$16,981

Taxable amount FBT rate (2020/21) FBT payable

Nil 47% Nil

Meal and entertainment benefits The grossed-up taxable value of salary packaged meal and entertainment benefits (including leasing of entertainment venues) that are provided by FBT concessional employers are included in the concessional FBT cap and in reportable fringe benefits. Prior to 1 April 2016, these amounts could be provided in addition to the cap. If the inclusion of meal and entertainment benefits causes the employee to exceed the cap, the FBT concessions (exemption or rebate) still apply provided the cap is not exceeded by more than the lesser of: • $5,000, or • the grossed-up taxable value of meal and entertainment benefits packaged.

¶10-630 Otherwise deductible rule

FBT may be reduced where the cost of providing the benefit would have been tax deductible to the employee if the employee had personally paid for it (¶3-500). For example, an employer may pay the premiums for an employee’s income protection insurance policy. If the employee had paid those premiums, the employee could have claimed a full tax deduction for them. The FBT is therefore reduced to nil. Also, where the price of the fringe benefit includes GST and the employer is entitled to an input tax credit, the net cost to the employer is only 10/11th of the price of the benefit. As the FBT is reduced to nil, the employer is able to pass the GST saving on to the employee. In addition, the employee can obtain a timing advantage. Having the employee’s premiums packaged saves the employee from meeting those costs from after-tax income and then claiming a tax deduction at the end of the financial year.

¶10-650 Remote area benefits Employers with a remote area workplace are in a position to provide their employees living in that remote area with a significant after-tax benefit by assisting with their accommodation in some way. Remote area housing provided by all employers is exempt from FBT (¶3-700). A 50% concession is available in relation to a number of other remote area benefits such as housing loan interest, residential fuel, loss on sale of home, remote area holiday travel and rent. The particular wording of FBTAA s 60(2A) is such that where the employer reimburses 50% of the cost of remote area rent, no FBT is payable (minutes of National Tax Liaison Group FBT Sub-committee meeting, 17 August 2006; Interpretative Decision ID 2003/159).

¶10-670 Expatriate and visiting overseas employees Employees who are classified as Australian residents working overseas for at least 91 consecutive days will only have their remuneration exempt from Australian tax if they are: • an aid or charitable worker working for a recognised non-government organisation • a government aid worker, or • a specified government employee (for example, defence and police force personnel deployed overseas). In these cases, any accompanying fringe benefits will be exempt from FBT. This also applies if an employee is a non-resident whose source of income is overseas. There are various other FBT concessions that apply to benefits provided to employees posted overseas, or for overseas employees posted to Australia. These concessions include home leave and children’s education expenses, a wide range of relocation and resettlement costs and medical treatment costs. The extent of these concessions offers considerable scope for tax-effective packaging. LAFHAs (see above) may also be relevant in this context.

CASE STUDIES ¶10-700 Understanding the case studies These case studies show the effect of packaging various benefits for employees on a range of salaries, using FBT rates for the 2020/21 FBT year. Assumptions Income tax rates FBT rate (2020/21 FBT year) Gross-up factor (¶10-200)

2020/21 47% 1.8868 or 2.0802

A gross-up rate of 1.8868 will be used if the employer is not entitled to an input tax credit in relation to the acquisition of the benefit. A gross-up rate of 2.0802 will be used if the employer is entitled to an input tax credit in relation to the acquisition of the benefit. SG contribution rate

9.5%

¶10-710 Case study one $80,000 pa employee Orbit Pty Ltd has a salary packaging policy that allows Alannah to package the costs of her existing private car using an associate lease. Alannah’s husband, Bill, is registered for GST. He acquires the car from Alannah and leases the car to Orbit for $7,700 pa (including GST). Assume that this amount of $7,700 is the current total car operating expenses. The car is valued at $20,000. The taxable value using the statutory formula is $4,000 (ie $20,000 × 0.20). Because the car is leased by Orbit Pty Ltd, the car will be a Type 1 benefit with a gross-up rate of 2.0802. The FBT payable in respect of the car is therefore $3,911 (ie $4,000 × 2.0802 × 47%). On Alannah’s existing salary of $80,000, Orbit’s SG contribution is $7,600. If Alannah elects to package her car, she chooses to have the same superannuation contribution of $7,600 as part of her package. Comparison of Alannah’s take-home pay amounts Without salary packaging Salary

$80,000

Less: tax and Medicare levy at 2020/21 rates (incl offsets)

$18,067

After-tax salary

$61,933

Less: car operating costs (incl GST)

$7,700

Net take-home pay

$54,233

Note: In addition to Alannah’s salary of $80,000, Orbit will contribute $7,600 by way of superannuation. Therefore, the total cost of employment is $87,600. With salary packaging Make-up of salary package Car operating costs ($7,700 × 10/11)

$7,000

FBT on car (2020/21)

$3,911

Superannuation contributions

$7,600

Adjusted salary

$69,089

Total package

$87,600

Note 1: Because Orbit receives a GST input tax credit of $700, the amount charged to Alannah’s package for the car is $7,000. Note 2: Alannah’s package of $87,600 is the same as the previous total cost of employment.

Adjusted salary

$69,089

Less: tax and Medicare levy at 2020/21 rates (incl offsets)

$14,303

Net take-home pay

$54,786

Alannah is better off by $553 (ie $54,786 − $54,233) through salary packaging. Reconciliation Reduction in personal income tax

$3,764

Savings in GST

 $700

Gross savings

$4,464

Less: FBT on car

$3,911

Net savings

 $553

¶10-720 Case study two $80,000 pa employee and employee contribution In this example the basic assumptions concerning Alannah’s situation remain unchanged except that Alannah now pays for enough of the car operating costs (ie $4,000 incl GST) to reduce the taxable value to nil (thereby reducing FBT to nil). Because Alannah has paid $4,000 car operating costs out of “after-tax income”, the charge to her package in respect of car operating costs is reduced by $3,636 (ie $4,000 × 10/11). With salary packaging and employee contribution New make-up of salary package Car operating costs

$3,364

FBT on car (2020/21)

$0

Superannuation contributions

$7,600

Adjusted salary

$76,636

Total package

$87,600

Adjusted salary

$76,636

Less: tax and Medicare levy at 2020/21 rates (incl offsets)

$16,907

After-tax salary

$59,730

Less: employee contribution

$4,000

New take-home pay

$55,730

Alannah is now better off by $1,497 (ie $55,730 − $54,233). Reconciliation Reduction in personal income tax ($18,067 − $16,907) Savings on GST ($7,700 − $4,000 = $3,700 ÷ 11) Gross savings Less: FBT Net savings Effect of contribution

$1,160  $336 $1,497 $0 $1,497

By making an after-tax contribution equal to the FBT taxable value of the car, Alannah has reduced the FBT to nil and has increased her savings by $944 (ie $1,497 vs $553 in case study one). In effect, she has substituted personal tax at 34.5% for FBT at 47%, while still receiving the advantage of the concessional valuation of the car fringe benefit. This has been partially offset by reduced GST savings of $364.

¶10-730 Case study three $120,000 pa employee Michael has a $120,000 package from Orbit Pty Ltd that includes a 9.5% employer superannuation contribution of $10,411. He can elect to package a range of benefits or he can simply take a cash salary of $109,589 plus employer superannuation contributions of $10,411 to make up the $120,000 total. If Michael packages a range of benefits into his total remuneration of $120,000, Orbit and Michael have agreed that the superannuation contributions will be 9.5% of the adjusted salary component. Assumptions Michael’s package

$120,000

Inclusions in package Car

$30,000

SG

9.5%

Laptop (100% business use)

$3,300

Annual work-related expenses (including diary, airport lounge membership, professional subscriptions, mobile phone rental and calls — primarily for business)

$2,200

Car running costs Novated lease payments

$9,000

Fuel

$3,300

Registration

$500

Insurance

$1,500

Repairs and maintenance

$2,000 $16,300

All costs include GST where applicable Kilometres travelled pa Business kilometres

20,000 Nil

FBT cost (statutory formula method) Taxable value ($30,000 × 0.20) Gross-up amount ($6,000 × 2.0802*) FBT ($12,481 × 47%) (2020/21)

$6,000 $12,481 $5,866

* Assume all lease payments are subject to GST and GST input tax credits are allowed.

Note: Because there is no GST on car registration, the charge to the package is the full price of registration. Make-up of package Car running costs ($15,800 × 10/11 + $500)

$14,864

FBT on car

$5,866

Laptop ($3,300 × 10/11)

$3,000

Work-related expenses ($2,200 × 10/11)

$2,000

Salary

$86,092

SG (9.5%)

$8,179 $120,000

Salary and SG 9.5% only Salary*

$109,589

Less: depreciation on laptop first year

$1,540

  other work deductions

$2,200

Taxable income

$105,849

Less: tax and Medicare levy at 2020/21 rates on taxable income of $105,849

$28,173

After-tax salary

$81,416

Less: laptop

$3,300

  work-related expenses

$2,200

  car running costs

$16,300

Net take-home pay

$21,800 $59,616

Note: * Michael’s employer contributes $10,411 into the employer-sponsored superannuation fund. Salary package with all benefits Adjusted salary

$86,092

Less: tax and Medicare levy at 2020/21 rates

$19,993

New net take-home pay

$66,099

Michael’s take-home pay is increased by $6,483 (ie $66,099 − $59,616). However, his employer SG contributions are reduced by $2,232 (equal to $1,897 after contribution tax of 15%). Reconciliation Reduction in personal income tax ($28,173 less $19,993)

$8,180

Savings on GST ($21,300 × 1/11)

$1,936

Reduction in employer SG contributions

$2,232

Total savings

$12,349

Less: FBT cost on car

$5,866

Michael’s cash advantage

$6,484

¶10-740 Case study four $180,000 pa employee (currently entitled to a benefit vehicle) Elizabeth has packaged a car into her total remuneration of $180,000. It has been agreed with Elizabeth’s employer, Planet Manufacturing Limited, that her package of $180,000 will include a superannuation contribution amount of $18,000. This contribution will remain the same irrespective of the mix of salary

and benefits. Elizabeth elects to include a second car into her package. Assumptions Car registration (no GST)

$500

Other car expenses (excluding GST)

$14,500

FBT

$5,000

Salary $142,000 Superannuation contributions

$18,000

Total package $180,000 Elizabeth negotiates with Planet Manufacturing Limited to package a second car with a capital cost of $25,000 and running costs of: Lease payments

$7,150

Registration (no GST)

$500

Fuel

$2,500

Insurance

$1,300

Repairs and maintenance

 $550

Total car running costs $12,000 Kilometres travelled (by second car): 20,000 km FBT cost (statutory formula method) Taxable value ($25,000 × 0.20)

$5,000

Grossed-up amount ($5,000 × 2.0802)

$10,401

FBT ($10,401 × 47%) (2020/21)

$4,888

New make-up of Elizabeth’s package of $180,000 Car No 1 Running expenses ($15,950 × 10/11 + 500)

$15,000

FBT

$5,000

Car No 2 Running expenses ($11,500 × 10/11 + $500)

$10,955

FBT

$4,888

Superannuation contributions

$18,000

Adjusted salary

$126,157 $180,000

Before packaging of second car Salary Less: tax and Medicare levy at 2020/21 rates

$142,000 $42,877

After-tax salary

$99,123

Less: motor vehicle expenses (second car)

$12,000

Net take-home pay

$87,123

After packaging of second car Adjusted salary

$126,157

Less: tax and Medicare levy at 2020/21 rates

$36,698

New net take-home pay

$89,459

Elizabeth is better off by $2,336 ($89,459 − $87,123) Reconciliation Reduction in personal income tax ($43,877 less $36,698)

$6,179

Savings on GST ($11,500 × 1/11)

$1,045

Less: FBT on second car

$4,888

Net savings

$2,336

GEARING The big picture

¶11-000

Gearing What is a geared investment and why gear?

¶11-010

What is negative gearing and why negatively gear? ¶11-050 Checklist on gearing

¶11-150

Gearing into geared investments

¶11-160

Borrowing Tax deductions and the purpose of the loan

¶11-200

Timing of tax deductions

¶11-220

Use of trusts and companies in negative gearing

¶11-225

Gearing foreign investments

¶11-230

Becoming non-resident

¶11-240

In whose name should the borrowing be made?

¶11-250

Use of guarantor or third party security provider

¶11-252

Maximising current and future after-tax returns

¶11-255

Gearing into managed funds

¶11-260

Effect of negative gearing on PAYG tax

¶11-270

Unsecured loans vs loans secured over property

¶11-330

Margin lending

¶11-350

Property loan or margin loan?

¶11-355

Risk of excessive gearing

¶11-360

Interest rates

¶11-400

Protected or insured loans

¶11-420

Borrowing and fixed interest investments

¶11-450

CGT trap on retirement

¶11-500

Gearing investments in superannuation funds

¶11-520

Geared investment projections

¶11-550

Other forms of geared investments Geared share managed funds

¶11-600

Options offered by companies

¶11-650

Instalment warrants

¶11-700

Endowment warrants

¶11-750

Exchange traded options and share futures

¶11-800

Full details of projections

¶11-900

¶11-000 Gearing and financial planning

The big picture What is a geared investment?: A geared investment is one that includes some borrowed funds .................................... ¶11-010 What is negative gearing?: An investment is negatively geared if the interest payable on the borrowing exceeds the income (rents, dividends or interest) received from the investment (after expenses), giving a negative cash flow .................................... ¶11-050 Risks associated with negative gearing: There are risks associated with negative gearing, including investment income risk, capital loss risk, interest rate risk and income risk. Additional risk exists in potential legislative changes limiting access to negative gearing for certain properties. A checklist for geared investments is provided at .................................... ¶11-150 Tax deductibility and the purpose of the loan: Interest is generally tax deductible in full if the purpose of the loan is to produce future taxable income. It is the purpose of the loan and how the funds are used which determine the tax deduction, not the security used to obtain the loan .................................... ¶11-200 Security for the loan: Investment loans are normally secured against an asset such as the home or, for margin lending, against the investments themselves. The security used can be partly or wholly owned by someone other than the borrower .................................... ¶11-250 Margin lending: Under margin lending, the loan is secured against shares and property trusts listed on a stock exchange and unlisted managed funds. Margin loans carry the risk of a margin call — where the loan balance exceeds the security value of the assets provided as security for the loan. Since the Global Financial Crisis (GFC) in 2007, margin loans have become less popular as many people were forced to sell their securities at a loss due to margin calls. .................................... ¶11350 Property loan or margin loan?: This table compares the features of a loan secured against property to a margin loan secured against shares .................................... ¶11-355 Interest on the loan: Interest can be variable or fixed, can be paid in advance and, in some cases, the arrangement can include protection against the value of the investment reducing .................................... ¶11-400 Selling the investment: The repayment of loans on retirement needs to be planned as realising investments may incur significant capital gains tax (CGT). Tax deductions for contributions to superannuation can be used to offset CGT .................................... ¶11-500

GEARING ¶11-010 What is a geared investment and why gear? In a geared (or leveraged) investment, part of the amount used to buy the asset has been borrowed. If, for example, an investment of $100,000 comprises $40,000 of the investor’s own funds and $60,000 borrowing, the investor’s equity is 40% and the level of gearing is 60%. Gearing (or leveraging) can also be achieved by using futures, options or warrants. The main advantage of a geared investment is that a 10% increase in the value of the investment asset increases the value of the investor’s equity by more than 10%. The investor’s return from the investment is increased or geared up. Unfortunately gearing has a similar effect if there is a loss in value. A 10% fall in the value of the investment will mean a greater than 10% fall in the value of the investor’s equity as

losses are also geared up. Gearing increases the investment risk (¶11-150) as it increases the profit from good investments and the loss from bad investments; thus it is not appropriate for cautious or conservative investors. Gearing only makes sense if the investment return (after tax and all expenses) from the investment exceeds the cost (after tax and all expenses) of the loan and the gain from the whole arrangement is expected to be large enough to make it worthwhile. This generally requires using growth investment such as shares and property. This is discussed at ¶11-050 and ¶11-150. ¶11-150 also includes a checklist on gearing. Borrowing and fixed interest investments are discussed at ¶11-450. Example Assumptions

Investor funds

$40,000

Borrowed funds

$60,000

Investment

$100,000

A 10% increase in the value of the investment asset would increase its value from $100,000 to $110,000. The borrowing would remain $60,000, so the investor’s equity would increase from $40,000 to $50,000, an increase of 25%. A 10% decrease in the value of the investment asset, however, would reduce the value of the investment asset to $90,000, reducing the investor’s equity to $30,000, a reduction of 25%. Not only has the investor’s equity of $40,000 been reduced by 25%, but the level of gearing has increased to 66.7% (loan remains at $60,000 on investment assets valued at $90,000). If the lender is only prepared to lend up to 65% of the value of the investments, for example, the investor would be required to make a margin call. This could be satisfied by: • providing a further $2,308 in assets as security for the loan, increasing the value of the security to $92,308 so the loan is 65% of the assets • repaying $1,500 to the lender to reduce the loan to $58,500 (65% of $90,000), or • selling $4,286 of the investment asset (and crystallising a loss) and using this amount to reduce the loan. The loan would then be $55,714, which would be 65% of the value of the remaining investment assets of $85,714.

¶11-050 What is negative gearing and why negatively gear? An investment is said to be negatively geared if the interest payable on the borrowing plus other expenses exceeds the income (rents, dividends or interest) received from the investment, giving a negative cash flow. If the income received from the investment exceeds the interest payable on the borrowings plus other expenses, the arrangement has a positive cash flow. The investment is then said to be positively geared. Fundamental rule of gearing The fundamental rule is that gearing (both negative and positive gearing) an investment is profitable (and hence makes sense) only if: • the return from the investment, including both income and capital gains, after tax and expenses, is expected to increase because of the borrowing • the increase in the return after tax and expenses is expected to exceed the cost of borrowing after tax and all expenses • the gain from the whole arrangement is expected to be large enough to make it worthwhile. This will generally require: • income from the investment (after income and other taxes and all expenses) which is expected to increase in future to cover the (after-tax) cost of borrowing, or • a market value of the investment (after income, capital gains and other taxes and all expenses including sale expenses) which is expected to increase at a rate which exceeds the negative cash

flow (after tax). Purely deferring income tax to a later year, or reducing income tax now in return for taxable capital gains later, does not, on its own, justify negative gearing. It can only be justified if the amount of tax payable later will be lower (because the capital gains are taxed at a lower rate than income and/or the taxpayer will be on a lower marginal tax rate), or if the taxpayer can get a significant benefit from the delay in payment and the whole arrangement makes enough money to make it worthwhile. In a tax-effective negative gearing arrangement (ie one in which future investment returns are expected to be in the form of taxable income) the negative cash flow will be tax deductible against other taxable income (this is discussed at ¶11-200). Why negatively gear? Essentially, if gearing an investment increases the return to the investor, then negative gearing, which represents a higher level of gearing, will increase the return further. But it is not that simple. Gearing also increases losses from poor investments and can increase other risks. A simple example which ignores expenses and tax is set out below. (More examples are provided at ¶11-550.) Example An investor has several investment options, based on an initial investment amount of $40,000: • investing $40,000 with no gearing • investing $80,000 with positive gearing by borrowing $40,000, or • investing $120,000 with negative gearing by borrowing $80,000.

Equity invested

Ungeared

Geared

Negative gearing

$

$

$

40,000

40,000

40,000

—

40,000

80,000

40,000

80,000

120,000

1,600

3,200

4,800

—

(2,400)

(4,800)

Net income or cash flow

1,600

800

0

Capital growth

2,000

4,000

6,000

Total return

3,600

4,800

6,000

40,000

40,000

40,000

9%

12%

15%

Borrowed Total invested Income received Less interest paid

Equity invested

Return on amount invested

Assumptions Income from investment is 4%. Capital growth is 5%. Interest on borrowing is 6%. The investment gives a return of $3,600 or 9% when ungeared, but this increases to $4,800 (12%) or $6,000 (15%) when geared or negatively geared. It is important to note what would happen if the market value goes down by 5% rather than increasing by 5%.

Ungeared

Geared

Negative gearing

$

$

$

Capital loss

(2,000)

(4,000)

(6,000)

Total return

(400)

(3,200)

(6,000)

39,600

36,800

34,000

(1%)

(8%)

(15%)

Equity remaining

Return on amount invested

The negatively geared investment has lost $6,000 (or 15%) and only $34,000 of the original $40,000 equity remains.

There are other reasons for the gearing (or negative gearing) of investments: • borrowing enables an asset such as an investment property or a business to be purchased without having to wait until the whole of the purchase price has been saved, or • borrowing enables a better and/or more attractive property or business to be purchased, or a larger investment to be made, which may give a better investment return or be cheaper to administer. It is interesting to note that borrowing to buy a property to live in or as an investment, or to buy a business, is widely accepted as normal practice, whereas borrowing to buy part of a business (ie shares either directly or through managed funds) is seen as risky. In fact, the principle is the same in each case.

¶11-150 Checklist on gearing Gearing is designed to increase the return from investment, but it also increases the uncertainty. By definition a negatively geared investment has negative cash flow before tax, although the cash flow may, in some cases, become neutral or positive after tax is taken into account. Gearing is usually attractive only for growth assets such as shares and property — over the long term these investments can be expected to give the higher rates of income and capital gains which make it attractive to borrow funds to make the investment. However, loans often have fees payable on establishment and/or repayment, share prices are volatile and can go down, and property is expensive to buy and sell. Thus, investment in these growth assets, particularly when the investment is geared, should only be made for a period of at least five years or, preferably, 10 years or longer. Risks associated with gearing • Investment income risk — if the investment income is lower than expected (eg an investment property cannot be rented, tenants default on rent payments or share dividends are reduced or suspended) or does not grow as expected, the negative cash flow will be larger than expected and continue for longer. Negative cash flow needs to be covered by income from other sources (usually salary). • Risk of capital loss — if the capital value reduces, and the investment is sold, the proceeds may not cover the loan. The remaining loan balance may need to be repaid from other assets. Investing in a well-diversified portfolio of assets may help to reduce the risk that the capital value will go down, or at least reduce the amount of any reduction. • Interest rate risk — interest rates on the loan may rise, increasing the negative cash flow needing to be covered from other sources. This risk can be managed by using fixed rate loans. • Income risk — income from other sources (generally salary) is needed to cover living costs as well as the negative cash flow. Salary may be reduced if overtime, sales or other bonuses are reduced or income ceases because of redundancy, sickness or injury, or death of the investor or their partner. Income and living costs can change following the ending of a relationship, separation or divorce.

• Legislative risk — In the 2019 Federal Election, the opposition government proposed major changes to negative gearing for owners of certain investment properties. Although the opposition government were not successful, there is always the potential risk that governments may change its policies. Many of the risks arising from a reduction in income can and should be fully covered by insurance — this insurance can be held either personally or within superannuation. Insurance should cover death, permanent disablement and temporary disablement. Insurance should cover the investor, but it should also cover the partner as a significant change in the partner’s circumstances will normally also significantly change living costs and the surplus cash flow available to cover negatively geared investments. Insurance is covered in Chapter 7. Checklist An investor should only make a geared investment if: • the investor has secure and permanent income from other sources sufficient to cover living expenses and all other requirements as well as the shortfall (if negatively geared) • where the gearing arrangement or borrowing includes a liability to make margin calls in certain circumstances, the investor can satisfy the margin calls by supplying further security or by payment from other sources to avoid the possibility of a forced sale (keep in mind that the economic conditions that lead to the need for a margin call will, almost certainly, mean that any forced sale will be at depressed prices and will lead to a significant loss to the investor). Diversifying the portfolio of investments may help to smooth out fluctuations in the market values of the investments and potentially reduce the risk of a margin call being made (see ¶11-350 — “Margin Lending”) • the investment is made on the understanding that it will be retained for at least five or, preferably, 10 years or longer • the investment and borrowing have sufficient flexibility to cover events such as death, disablement, major illness or redundancy. The first three of these would normally be covered by insurance or superannuation benefits and redundancy could be covered by an employer payout. However, even in these circumstances the gearing arrangement (either the borrowing on its own or both the investment and the borrowing) may need to be terminated. Check whether this could be done without incurring penalties and with the flexibility to avoid suffering loss through a forced sale of the asset • there is flexibility to cover changes in circumstances, such as a transfer overseas (where the tax advantages may not apply — see ¶11-240 for the effect on tax payable in Australia) or divorce • for negative gearing the taxpayer can take full advantage of the tax deduction. Negative gearing normally works best for investors on the highest marginal tax rate but may be of less value to low tax rate or non-taxpaying investors (¶11-250–¶11-255). Negative gearing may be less attractive after retirement because many investors who were on a high marginal tax rate when working will pay little, if any, tax in retirement, particularly after age 60 when superannuation is tax-free • lenders and financial advisers must carry out certain checks before a margin loan can be recommended (¶11-350).

¶11-160 Gearing into geared investments Many investments, such as listed property trusts and property syndicates, and most companies, whether listed or unlisted, borrow money as part of their normal operations and hence are already geared. Caution is required when gearing into an investment that is already geared to ensure the overall level of gearing is understood. If the level of gearing is excessive, even a modest downturn in the economy could reduce the value of the investment below the level of the borrowing. Realisation at that time would not only mean that the investor had lost whatever equity they had invested, but they would still have at least part of the loan to repay.

BORROWING ¶11-200 Tax deductions and the purpose of the loan Interest paid on borrowings made for the purpose of securing taxable income is normally tax deductible. With a negatively geared investment, interest and other expenses exceed the income received from the investment and this excess may be deductible against other taxable income. The deductibility of interest is determined by the purpose of the loan, not by what is used as security for the loan or who provides the security. Interest paid on borrowings used for private purposes or to make contributions to superannuation are not tax deductible. Where the borrowings are for a mixture of purposes, part of the interest that relates to the securing of future taxable income can be tax deductible. Redraw facilities need to be treated with care. Each and every time the redraw facility is used the redraw is regarded as a new loan for tax purposes — so even with an investment loan interest on a redraw that is used for private purposes will not be tax deductible. This has been confirmed in Domjan v FC of T 2004 ATC 2204. In the case of an investment such as a holiday home which is partly used for private purposes and partly for investment purposes, part of the interest (and other expenses) may be allowed as a tax deduction provided the investment is made with a realistic expectation of generating taxable income and the investment is managed in a commercial manner. In particular, a holiday home should be made available for rent during holiday periods and should not normally be rented out at less than commercial rates during those times. The ATO looks closely at rental property owners incorrectly or falsely claiming deductions for properties that are not genuinely available for rent or are used by taxpayers as a personal holiday home. Deductions can only be claimed for the rental property to the extent the property is genuinely rented out, and if rented out to friends or families at mates rates, the deduction can only be claimed up to the amount of income received. Proper records should be maintained including details of the property’s income and expenses, evidence of the property being rented or genuinely available for rent at market rates and of who stayed at the holiday home and when, including the time when the property is used for personal purposes. There should be a direct link between the funds borrowed and the amounts invested to ensure the full tax deduction. Thus, the investments should be made directly with the borrowed funds, although funds can be held in cash in an interest-bearing account on a temporary basis. It is preferable not to mix the borrowed funds with private funds before the investments are made. It cannot be assumed, however, that interest on all negatively geared investments will be deductible — the taxpayer must intend at the outset that the negative cash flow will eventually become positive. If the earning of assessable income is not the taxpayer’s only motive in entering into the transaction the interest deductions may be partially (or wholly) disallowed. The Australian Taxation Office (ATO) has commented in Taxation Ruling TR 95/33 that if, after considering all the circumstances (including the objectives of the taxpayer) in a common sense and practical manner, it can be concluded that the disproportion between the outgoing and the relevant assessable income is essentially to be explained by reference to the independent pursuit of some objective other than the production of assessable income (eg to derive exempt income, capital gains or obtain a tax deduction), then the outgoing will be partially or wholly disallowed. The outgoing may need to be apportioned. Investments not producing taxable income A deduction may not be available for interest on borrowings where an investment is acquired with the purpose of achieving a return wholly in the form of a capital gain at the end of the investment period. To qualify for an interest deduction, the borrowing needs to be undertaken with the purpose of earning assessable income in the form of ordinary income (eg rents, dividends or interest) as well as taxable capital gains. Where the only return received is a capital gain at the end of the investment period, this may not be sufficient to justify a deduction for interest during the investment period. However, for CGT purposes, the

non-deductible interest would form part of the cost base of the investment and reduce the amount of the capital gain subject to tax at the end of the investment period. Good examples of investments where this treatment of interest can arise include: • a vacant block of land acquired and then sold some years later • capital units in a managed fund (unit trust) where there are generally no distributions of taxable income to shareholders. In situations like these, where the interest is not deductible, other expenses relating to the maintenance of the investment or asset will be treated in a similar way. This means that the expenses will not be deductible initially, but they will form part of the cost base of the investment when calculating the capital gain on disposal. The types of deductions available to investors and the rules which apply are discussed at ¶1-325.

¶11-220 Timing of tax deductions An outgoing may be deductible in a year of income although the assessable income motivating the outgoing is not generated until a subsequent year of income. There must, however, be some connection between the outgoing and the future income. Where deductions associated with an investment (¶1-325) exceed the assessable income derived from the investment in any particular income year (ie “negative gearing”), the excess can be used to reduce the tax payable on other assessable income of the investing taxpayer. Clearly, negative gearing can be particularly useful to taxpayers on high incomes.

¶11-225 Use of trusts and companies in negative gearing Negative gearing transactions may involve the use of family trusts or companies. Note that if a trust holds a negatively geared investment and does not have any other taxable income, the loss would be carried forward, as a trust cannot distribute a loss. Similarly, a company cannot distribute an income loss and does not benefit from the 50% discount available to individuals under CGT.

¶11-230 Gearing foreign investments Negatively geared investments can generally be made tax effectively using foreign assets as well as Australian assets. The excess of “interest and related expenses” paid over investment income received is a deduction against other income. Tax legislation limits the deduction to the income received from the foreign investment, any excess deduction is quarantined and cannot be used to reduce tax on other income. However, in 2001 the thin capitalisation legislation removed “interest and related expenses” from those quarantining provisions in all but some limited circumstances for individual investors. Other expenses would still be quarantined, but these are less likely to require it. Some foreign investments, particularly managed funds, can be expected to give an investment return in the form of capital gains rather than income. These may not be suitable for a negatively or positively geared investment as the investor may not be able to use the tax deduction for the interest as there is little taxable income in the current year and little expectation of taxable income in future years (¶11-200).

¶11-240 Becoming non-resident Moving overseas and becoming a non-resident for tax purposes can have a significant effect on the effectiveness of geared investments from an Australian taxation point of view. Dividends and interest paid in Australia to non-residents are subject to withholding tax. This is a final tax and the income is not included in assessable income in Australia. Interest paid on any borrowing would not, then, be tax deductible in Australia as the investments are not generating assessable income. In

addition, non-residents are not entitled to the 50% capital gain tax concession. If a taxpayer is a resident and non-resident during the period of owning an investment property and sells while a resident, the CGT concession can be applied on a relative apportionment basis.

¶11-250 In whose name should the borrowing be made? A geared investment comprises: • equity — the amount of their own money invested, and • the loan — the amount borrowed. For a couple, in general the equity would be invested in the name of the partner on the lower marginal tax rate and any loan and associated investments should be made with the loan funds being in the name of the partner on the higher marginal tax rate. Joint names would generally be used for a couple on the same marginal tax rate. This is discussed in detail at ¶11-252 and ¶11-255. Note, however, that depending on the loan arrangement, it may not be possible to have all of the equity in one person’s name and all of the borrowings in another person’s name. Also bear in mind that an individual’s marginal tax rate might change from year to year over the term of the investment. Borrowing, like investments, can be incurred in the name of the investor, their spouse or other family member, in joint names or in the name of a trust or company. The name that should be used for the borrowing is determined by two main factors: • the requirements specified by the lender, and • maximising the current and future after-tax return of the arrangement. Requirements specified by lender The requirements specified by the lender will relate to the ability of the borrower to make repayments and the security that the borrower can provide to the lender.

¶11-252 Use of guarantor or third party security provider In many cases a guarantor (or third party security provider) can be used if the particular borrower is not able to satisfy the lender’s requirements on their own. If the interest paid is tax deductible, the tax deduction would be available to the taxpayer who borrowed the funds and paid the interest. Whenever a guarantor is used for borrowing, care must be taken to ensure that all parties understand the arrangement and the liabilities that they are undertaking. If the borrower defaults on the loan, the security provided by the guarantor (which can often be the family home) can be lost, whatever the circumstances or reason for the loan default. The implications of the use of a spouse and other relatives to provide guarantees and third party security can be quite significant, and lead to a problem of unexpected debt. Such arrangements should not be entered into lightly. Using guarantees for tax efficiency Example Tax efficiency with a third party security provider Hugo is on a high marginal tax rate and Laura is on a low tax rate. As a couple, they are looking to make a geared investment of $100,000 comprising $40,000 equity and $60,000 borrowings. For tax efficiency they should: – borrow the $60,000 in Hugo’s name and also invest it in Hugo’s name. The investment made with the $60,000 could be part of the security for the loan, if required – invest their equity of $40,000 in Laura’s name. If required, the investment made with the $40,000 could be part of the security for the loan if Laura were a party to the loan agreement as a third party security provider. Taxable income from the $40,000 equity would then be taxed at Laura’s lower rate while the tax effect of Hugo’s loss would be

maximised. Hugo may also be able to take the income from the investment in his name in cash, rather than reinvesting it, and invest the after-tax proceeds in Laura’s name. This would maintain a higher level of negative gearing for the investment in Hugo’s name that benefits from his higher marginal tax rate while increasing the equity investment in Laura’s name that benefits from her lower marginal tax rate. Aggressive schemes, however, which limit Hugo’s return and benefit Laura may be punished by the ATO as tax avoidance under Pt IVA of the Income Tax Assessment Act 1936 (Cth) (ITAA36).

¶11-255 Maximising current and future after-tax returns A negatively geared investment will give rise to a negative cash flow and a net tax deduction in the early years. However, the cash flow and the tax position will change in later years so that the investment will produce taxable income which exceeds the interest cost. The arrangement has then ceased to be negatively geared and it gives net taxable income rather than a tax deduction. For some investments, such as property, the cash flow and tax position is expected to remain negative for a fairly long period. In other cases, perhaps shares, while initially the cash flow and tax effect may be negative, growth in dividends and franking credits may well mean that the arrangement ceases to be negatively geared within a few years. The relevance of this for investment using managed funds is discussed in ¶11-260. The general rule is that, while the arrangement is generating a tax deduction, it will be best to have income, and hence the tax deduction, flowing to the taxpayer with the highest marginal tax rate. Accordingly, for arrangements likely to stay tax negative for long periods, it may be appropriate to have the investment structured in the name of a taxpayer on a high marginal rate. Once the arrangement is tax positive (whether or not it is cash flow positive), it is tax effective to have the borrowings and investments in the name of a taxpayer with a low marginal tax rate. If the geared investment is likely to be tax positive within a short period, it is probably best to set up the arrangement in the name of the taxpayer with a low marginal tax rate from the start. It is not practicable to alter the borrowings and investments when the tax position moves from negative to positive because of the costs involved, eg stamp duty, CGT (as the alteration in the ownership of the investments will trigger capital gains tax) and loan establishment and discharge fees. A number of projections are set out in detail in ¶11-550. Two of these projections, Residential Property and Direct Shares (Margin Loan), using the expected projection, can be used to illustrate the points made above. The projections have been run on tax rates of 47%, 34.5% (both including Medicare levy) and 0%. The results are summarised in the following charts and table. Maximising after-tax returns

Note The after-tax cash flow quoted includes the $7,500 new investment each year, so a figure below $7,500 indicates that the after-tax cash flow from the investment is negative.

Residential Property

Direct Shares (Margin Loan)

Tax rate

47%

34.5%

0.00%

47%

34.5%

0.00%

Net equity at end of Year 10

$132,714

$122,880

$84,278

$178,908

$177,393

$162,233

Yield pa*

11.1%

9.6%

2.3%

16.7%

16.5%

14.8%

* Total return (income and capital gains) to the investor, after income and CGT and after repaying the loan, if the investment was sold at the end of Year 10.

Under the Residential Property projection, the after-tax cash flow remains negative throughout the 10year period after taking account of the $7,500 new investment each year, so the higher rates of tax reduce the income loss and give a higher overall return. For the Direct Shares (Margin Loan) projection, the after-tax cash flow remains negative until after Year 10 but will cover the $7,500 invested each year first for the highest tax rate. However, once the CGT liability is taken into account the net equity and hence after-tax return is very similar for the 47% and 34.5% tax rates and the zero rate taxpayer is starting to close the gap by Year 10. The returns will favour the zero rate taxpayer, not the highest rate taxpayer within a few years thereafter. This trend is shown in the charts. The after-tax cash flow quoted includes the $7,500 new investment each year, so a figure below $7,500 indicates that the after-tax cash flow from the investment is negative. For a couple establishing a geared investment, the issue “in whose name should the borrowing be made?” is important and can be quite difficult, needing careful consideration at the time the arrangement is established. Two final comments on the Direct Shares (Margin Loan) projection: • the after-tax return will increasingly favour the zero rate taxpayer the longer the arrangement is held beyond 10 years • the tax position will swing back towards the high rate taxpayer if the arrangement is realised when the marginal tax rate is lower, eg following retirement. This would significantly reduce the $43,758 CGT paid on realisation in the 47% tax rate projection. Full details of the projections and the assumptions are set out in ¶11-550.

¶11-260 Gearing into managed funds The use of managed funds can be a very convenient way of establishing a geared investment. See ¶11230 for comments on gearing into managed funds investing in international shares and on gearing into

managed funds with a diversified range of investments. Most fund managers, however, actively trade their portfolio with the aim of increasing the return to investors. As a result, the funds can be expected to realise significant gains and these gains, together with investment income, must be distributed each year (and much of the distribution will be taxable). Distributions from these managed funds in recent years have often been 7% pa or more, which may exceed the interest payable on the borrowings, so, even with 100% gearing, the investment may be positively geared rather than negatively geared. As a result, it may be more tax effective to invest these geared investments in the name of a low taxpayer rather than a high taxpayer. The expected projection for the managed fund (Australian shares) from ¶11-550 has been run on a tax rate of 47%, 34.5% and 0% to illustrate this point. The comparison depends critically on the level of capital gains realised in the managed fund which are then distributed to the unitholder — this varies significantly from year to year. The results are summarised in the following charts and table.

Managed Fund — Australian Shares Tax rate

47%

34.5%

Net equity $177,249 $173,374 Yield pa*

16.5%

16.1%

0.00% $153,124 13.7%

* Total yield (income and capital gains) to the investor, after income and CGT and after repaying the loan, if the investment was sold at the end of Year 10.

The after-tax cash flow is positive as it exceeds the $7,500 new investment each year: • from Year 4 for the 47% tax rate

• from Year 6 for the 34.5% tax rate • from Year 9 for the zero tax rate. When the investment is sold at the end of Year 10, the returns for the 47% and 34.5% tax rates are almost equal and will progressively favour the lower rate taxpayers for longer durations. The tax position will, however, swing back towards the higher rate taxpayers if the arrangement is realised when the marginal tax rate is lower, eg following retirement. This would significantly reduce the $25,729 (on 47% tax rate) or $18,886 (on 34.5% tax rate) CGT paid on realisation in this projection. The charts illustrate the trends. Full details of the projections and the assumptions are set out in ¶11-550. Use of diversified funds Diversified managed funds (eg balanced or growth funds) invest across the whole range of asset classes, including Australian and international fixed interest and cash. Caution is required in using borrowed funds when investing in diversified funds if the after-tax cost of borrowing is likely to exceed the after-tax return for a significant part of the investment because of the diversified fund’s investment in fixed interest and cash. Investments made with non-borrowed money in diversified funds can, however, be used as security for margin lending (¶11-350). Such an arrangement may result in the investor holding funds in a low interest rate investment within the diversified fund while also having borrowings at a higher (after tax) interest rate (see ¶11-450).

¶11-270 Effect of negative gearing on PAYG tax The tax deduction under negative gearing would reduce the liability for Pay As You Go (PAYG) tax for taxpayers who are not employees. A taxpayer who is an employee subject to PAYG tax and who is entitled to significant deductions, eg from negative gearing, is entitled to ask the ATO to authorise the employer to vary the amount of the PAYG deduction. The reduction in the PAYG tax deduction will improve the investor’s cash flow as the tax advantages will be spread throughout the year via the reduction in PAYG tax, rather than waiting for a lump sum refund of overpaid tax at the end of the year. There are severe penalties if the variation requested leads to an underpayment of tax during the year. The rules which apply to PAYG tax are discussed at ¶1-105.

¶11-330 Unsecured loans vs loans secured over property Unsecured loans An unsecured loan normally has a higher rate of interest than a loan secured by property or other assets. The lender will require the borrower to have a secure cash flow as this cash flow is the lender’s security that the loan will be repaid. Because of the higher interest rate, an unsecured loan would normally only be used when the borrower does not have assets available to use as security. This would be unlikely when borrowing for the purpose of geared investment as the investment itself should be able to provide at least some security for the loan. Secured loans A loan secured against a home or other property (a “property loan”) is the traditional way for banks to make a loan to individuals, either to buy their own residence or to buy property, shares or other assets for investment purposes. Many other finance providers also offer home loans and investment loans secured against property. All finance providers have clearly established procedures for arranging loans. The loans normally require extensive documentation and normally have significant establishment costs. Interest rates are lower for property loans than for other forms of borrowing, and the market is very

competitive. Interest needs to be paid regularly. Many lenders require repayments which exceed the interest payable so that the loan capital will be repaid over a set period. Borrowers may have only limited flexibility to increase or reduce repayments or to redraw amounts repaid early. Penalties may be imposed on early partial or total repayment of the loan. The borrower must satisfy all the conditions of the loan, including making at least the minimum repayment on time. However, the borrower will generally have considerable freedom in making and changing the investments, and margin calls will not be required. Security The security for the loan can be quite independent of the investments made with the borrowed funds. The security provided for the loan, including the family home if used as security, is at risk of being sold if there is a default under the loan, whatever the cause of that default. The default could be caused by failure of the investment made with the borrowed funds or because of the sickness, death or redundancy of the borrower. See ¶11-252 — “Use of guarantor or third party security provider”.

¶11-350 Margin lending Under margin lending, the loan is secured against shares and property trusts listed on a stock exchange and unlisted managed funds. Some of these will be existing investments which represent the borrower’s equity, with the balance being new investments purchased with proceeds of the loan. An example is set out below. Margin lending is offered by many banks and other finance providers including stockbrokers. The lender provides a list of the specific securities that it will accept, and nominates a percentage of the market value for each security which is the maximum amount that it will lend against that security. The interest rate is normally higher for margin lending than for a property loan. Establishment costs can be lower than for property loans. The list of securities provided by the lender should be checked by the financial planner as any investment made outside this list cannot be used as security for the loan or to satisfy a margin call. The loans are normally arranged as a line of credit and are very flexible. They do not normally specify a repayment that must be made; the only requirement is to satisfy a margin call if the level of security falls too low. Repayments can be made on a regular or ad hoc basis, or the income from the investments can be credited to the account. Interest will be debited to the account and, if not paid, will be capitalised as part of the loan balance. If repayments from all sources do not cover interest the amount of the loan will increase which will increase the level of gearing and could lead to margin calls. Loans can be partly or fully repaid and subsequently redrawn with little, if any, cost. This can be done on a regular basis, which allows the borrower to take advantage of opportunities to sell or buy investments on short notice. If the investor is active in buying and selling shares or other investments, settlement for each trade can be made by debiting or crediting the investor’s margin lending account — provided only that the balance remains within the borrower’s approved credit limits, including the value of investments used as security for the loan. Margin lending is normally “non-recourse”, meaning that in the event of default on the loan, the lender only has access to the specific assets given as security. It is critical that anyone taking out a margin lending loan fully understands the way in which it operates, including the possibility of having to make a margin call. Margin calls are normally payable within 24 hours. All borrowers must be able to satisfy any margin call within this time. Because a margin call requires a response within 24 hours it is important for the investor to monitor the margin loan on a regular basis to allow time to take action, if needed, to avoid a possible margin call or at least to be prepared for it. Monitoring should cover: • the value of the portfolio of investments used as security for the loan • the loan value of these investments, keeping in mind that the lender may, from time to time, change the loan value of one or more of the investments and hence change the loan value of the portfolio

• the amount of the loan. The list of acceptable securities may include some investments for which the deductibility of interest is in doubt in some circumstances (eg an investment where the investment return is expected to be in the form of capital gain rather than taxable income). A possible strategy is for these investments to be acquired using specifically non-borrowed funds only. Any residual amount of the non-borrowed funds could then be used, together with the borrowed funds, to purchase investments for which the deductibility of interest is not in doubt. The tax advantages of using a third party security provider on a lower tax rate are available under margin lending (see ¶11-252). Caution Financial advisers are only able to recommend a margin loan if they are reasonably sure the investor can afford the loan without suffering substantial hardship. Lenders are also required to assess a person’s “true” loan-to-value ratio, meaning that they will no longer be able to assume that the money put forward as collateral for margin loan is not itself debt; for example, where people have been advised to take equity out of their family home and use this debt to leverage into buying shares through a margin loan (see ¶11-360 — “Risk of excessive gearing”).

Example Scooter wishes to develop a $75,000 investment portfolio from savings of $30,000 using margin lending. The savings of $30,000 are invested as $10,000 into a managed fund (international shares) and $20,000 into a diversified managed fund. These investments are then used as security for a margin lending loan. The lending margin for both funds is 60%. $45,000 is borrowed under the margin lending loan with $30,000 invested into a managed fund (Australian shares) and $15,000 directly into Commonwealth Bank of Australia (CBA) listed shares. The lending margin for each of these new investments is 70%.

Portfolio value

Margin value

$

%

$

Managed fund (International shares)

$10,000

60

$6,000

Diversified managed fund

$20,000

60

$12,000

Managed fund (Australian shares)

0

70

0

CBA

0

70

0

Total

$30,000

Starting portfolio

Safety margin

=

1

−

$18,000

$0  $18,000+(5%×$30,000) 

=

Purchases using margin lending $ Managed fund (Australian shares)

$30,000

CBA

$15,000

Total borrowings

$45,000

Portfolio value $ New portfolio

Margin value %

$

100%

Managed fund (International shares)

$10,000

60

$6,000

Diversified managed fund

$20,000

60

$12,000

Managed fund (Australian shares)

$30,000

70

$21,000

CBA

$15,000

70

$10,500

Total

$75,000 Safety margin =  (new portfolio) 

1

−

$49,500

       $45,000       = 15.49%  $49,500 + (5% × $75,000) 

Scooter’s total portfolio is now worth $75,000, the margin value is $49,500 and the loan is $45,000, giving a gearing level of 60% and leaving available funds of $4,500. The safety margin is 15.49% — this is the maximum percentage that the value of the assets can fall before a margin call would be required. The safety margin includes a 5% buffer which is allowed by most margin lenders. The buffer is typically 5%–10% and it means that for a security with a lending margin of, say, 70%, the lender will allow the loan to grow to 75% (if the buffer is 5%) or 80% (with the buffer is 10%) of the value of the security before making a margin call.

Reducing the risk of a margin call A main way to simply reduce the risk of having to make a margin call while using a margin loan is to keep the level of gearing low, below about 50%. If you are using a margin loan to gear into an investment with a lending margin of 70% and the gearing is kept to 50%, the market value of the investment has to drop by 33% before a margin call will be required. This gives the investor a large safety margin. Other ways of reducing the risk include: • making sure the investments are well diversified. This can be expected to smooth out fluctuations in market values thus reducing the risk of a margin call, and • monitoring on a regular basis the market values of the investments, their loan values and the amount of the loan. Action can then be taken on a timely basis to avoid or be prepared for any margin call. Instalment gearing Some margin lending facilities have a regular or instalment gearing or savings option. For practical reasons investment may be restricted to managed funds, but the initial investment can start from approximately $3,000 — equity of $1,000 and borrowing of $2,000. The investor then increases the equity by regular monthly amounts which are matched $2 for $1 (or the agreed proportion) by borrowed funds, subject to the credit limit approved for the borrower. This could be a convenient way to start accumulating geared investments by instalments — although expenses and the interest rate are likely to be higher because of the small amount of the loan in the early years. Margin calls The lender will make a margin call on any day when the loan balance exceeds the security value of the assets provided as security for the loan. Most lenders will allow a buffer of 5%–10% when determining if a margin call is required. This means that for a security on which a 25% loan is allowed, the lender will allow the loan to be 30% (with a 5% buffer) or 35% (with a 10% buffer) before making a margin call. Once made, the borrower must satisfy the margin call (usually within 24 hours) or the lender can sell a sufficient quantity of the assets lodged as security to satisfy the call. Normally a margin call is caused by a reduction in the market value of the investments, thus any sale of the investments to satisfy the margin call will be at this lower price. Where a margin call is made, an investor can respond by: • lodging further assets as security • lodging cash or other funds to reduce the loan, or • selling other assets and using the proceeds to reduce the loan.

Margin lending has become less popular since the GFC where investors were forced to sell at a loss due to margin calls. Reserve Bank of Australia (RBA) data shows that since 2007, the total value of margin loans held has decreased by 75%. Additionally, the loan to value required for a margin loan is now 25% compared to 50% pre-GFC. This represents are smaller appetite for risk among borrowers and lenders. Margin calls and COVID-19 During the GFC, the negative impact of margin calls is well documented. However, post-GFC, margin lending has fallen out of favour and instead investors are more likely to seek funding through other means. The latest RBA and bank data show that the level of margin calls made during the COVID-19 share market crash in March 2020 was about one-quarter to one-third of the levels seen during the peak of the GFC in 2008. Diversifying an investment portfolio A margin loan can be used to diversify a concentrated investment portfolio while avoiding the need to sell some of the investments and incurring capital gains tax. Example Anne bought 1,000 CBA shares in the original government float at a share price of $5.40. These are her only investments and have proved to be a very good investment as the share price is now $80, giving her a portfolio worth $80,000. Anne wishes to diversify her investments. She could sell some of the shares and use the proceeds to buy other shares, but then she would have to pay a significant amount of capital gains tax. Alternatively, she could retain all the CBA shares and use them as security for a margin loan of up to $20,000 to invest in other shares. Overall Anne has increased and diversified her investments without incurring capital gains tax while keeping her gearing level to 20%.

¶11-355 Property loan or margin loan? The table below compares some of the features of a loan secured against property to a margin loan secured against shares or other investments. Property Loan

Margin Loan

Setting up the loan

Generally extensive documentation required with significant costs

Generally less documentation and lower costs

Interest rate

Generally lower rates

Generally higher rates (approximately 1.5% to 2% higher)

Repayments

Regular payments prescribed by lender and these must be paid on time. Interest-only loans normally available. Additional payments and redraw facilities may be available

Borrower has total flexibility provided loan remains within approved credit and margin call limits

Security

The family home. Approval of spouse required if in joint names. Home at risk and can be sold if default on loan for any reason

Security limited to the nominated investments only

Margin calls

None

Required whenever loan exceeds lending margin of nominated investments. Generally payable within 24 hours or investments will be sold

Investments

No restrictions applied by lender

Only investments acceptable to the lender can be used as security

¶11-360 Risk of excessive gearing

In practice, geared investments could use a combination of a property loan and a margin lending loan (eg $250,000 could be borrowed as a property loan against the security of a house and invested. These investments could then be used as security for margin lending of $500,000 which is also invested. The total amount invested is $750,000, which is all derived from borrowed funds). However, discipline must be exercised. The investor and all security providers must understand the borrowing arrangements and the liabilities involved. In addition, the total level of borrowings must be kept to a reasonable level having regard to the financial position of the investor. Following an Australian Securities and Investments (ASIC) review into double lending (as illustrated above) margin lending providers have changed lending practices for these loans to reduce risk. Changes include extra buffers to allow for increases in interest rates, lower maximum loan limits and lower loan-tovalue ratios. Of particular concern are borrowers who would not be able to service the borrowings from their available income.

¶11-400 Interest rates Most lenders offer a choice between variable and fixed rate loans, or a combination of these, together with the option to pay interest in advance. Some lenders offer considerable flexibility for borrowers to swap between these options and to combine them at little or no cost. This flexibility may be valuable for many borrowers. Variable rate A variable rate: • is the most common basis for calculating interest under property loans and margin lending • is set by the lender and can be changed at quite short notice • is normally based on the cash rate set by the RBA, plus a margin, and will normally increase or reduce with any change in the cash rate • normally has few, if any, penalties for early termination, giving the borrower maximum flexibility to vary repayments, etc • is subject to competitive pressures limiting the ability of the lender to increase the rate unreasonably, as the borrower can arrange a new loan elsewhere and repay the original loan • has an interest rate that is generally (but not always) lower than for fixed rate loans. Fixed rate In fixed rate loans: • the interest rate can be fixed for a term (generally from one to five years); at the end of which, the loan would normally revert to a variable rate, unless it is fixed for another term. • the rates will normally be higher than variable rates • like in a debenture, there may be no flexibility to vary the interest rate or the amount of the repayment, make an early partial or total repayment of the loan, or make a further drawdown on the loan within the term of the fixed rate; any flexibility in these conditions would be set out in the loan contract • the borrower is protected from any increase in interest rates but does not benefit from any reduction in rates for the duration of the fixed term • the protection against possible increases in interest rates during the term of the fixed rate can be particularly valuable for a borrower who has limited means to accommodate any increase in repayments. A loan which is partly subject to a variable rate with the rest being fixed can offer some protection against

rising interest rates while still allowing the flexibility to make additional repayments under the variable rate part. Some loans offer a rate which will not increase if rates go up but will reduce if rates come down. This could be attractive, depending on the rate and conditions offered and any restrictions or penalties applied to early repayment. Interest paid in advance Interest is normally charged or paid monthly at about the end of each month. If the interest is a tax deduction, it is deductible in the year it is paid. Many lenders offer borrowers the right to pay interest in advance, generally with a reduction in the rate. The rate should be lower, if only because it has been paid in advance. Interest paid in advance means that the loan effectively becomes a fixed rate loan which locks in both the amount of the loan and the interest rate. This may or may not be a good idea, depending on the circumstances. A margin loan where interest is paid in advance can still be subject to a margin call if the value of the investments falls. If the amount of the loan is reduced as a result of the margin call, this would reduce the amount of interest payable; however, when interest has been paid in advance, the excess interest may not be refunded. If interest is a tax deduction, interest paid in advance is also a tax deduction. Small business entities are eligible to deduct prepaid expenses under the special rules in ITAA36 s 82KZM. Non-individual taxpayers who do not carry on a business, such as family companies or trusts that operate purely for investment purposes cannot claim an immediate deduction for prepaid interest; taxpayers must apportion the deduction over the relevant period.

¶11-420 Protected or insured loans A number of providers of margin lending in the past have offered protected loans where, in return for a higher interest rate, the investor was protected, either partly or fully, against a reduction in the market value of the shares or managed funds held under the margin lending facility. The protection also avoided the need to make margin calls. Few, if any, margin lenders still offer these loans. However, as loans could have been for a term of five years or more, existing loans could continue for a number of years. Interest rates on protected loans can be up to 20% or more. As with other margin loans, interest paid on a protected loan can be tax deductible if used to purchase investments expected to produce taxable income. However, part of the “interest” charged in these products is a capital protection fee which is not deductible under the general deduction provisions as the purpose of this fee is to give the taxpayer capital protection in the event of a share price fall. A form of capital protected investment is still available. The capital protection is provided by a put option which gives a guaranteed value for the investment at the expiry date of the put option. The investment can be 100% geared with the loan being repaid on the expiry date of the put option. Regular payments will need to be made on the loan, these covering interest and a charge for the put option, however, provided these payments are made no margin calls will be required. The loan, however, does not have the flexibility of a standard margin loan. The interest rate charged, the cost of the put option and the effect of any limitation on the tax deductibility of these costs will need to be taken into account in any decision to make a geared investment in this form. These factors will reduce the likelihood that any profit after tax and other expenses from the arrangement will be large enough to make it worthwhile. The tax deduction for interest on Capital Protected Borrowings (CPBs) is covered by legislation. Capital Protected Borrowings exists where the: • borrower is wholly or partly protected against any fall in the market value of an asset to which a loan relates • borrower either purchases the assets being protected with borrowed funds or the protected assets are used as security for the borrowing

• loan is either a limited or full recourse loan facility, and • borrower is able to transfer the underlying assets back to the lender in order to satisfy their loan obligation (eg where there is a fall in the market value of the asset price). The most common type of CPBs are instalments (see ¶11-700) and capital protected loans. The tax deduction for interest paid under a CPB is limited to the amount of interest calculated using the RBA benchmark rate of interest for a variable rate standard housing loans (as at April 2020 this rate was 4.52% for an owner-occupier or 5.10% for an investor) increased by 1%. Thus the tax deduction for interest paid under CPBs will be limited to 5.52% for an owner-occupier or 6.10% for an investor (based on rates as at April 2020). Interest that is not deductible can be included in the cost base for CGT purposes.

¶11-450 Borrowing and fixed interest investments An investor can borrow and use the funds for fixed interest investments. In practice, however, such an arrangement does not normally make sense unless the investor borrows at a low (after-tax) rate of interest and receives a higher (after-tax) rate on the investment. This is most unlikely and, if it did occur, it would raise questions on the level of risk being taken in the investment. A similar position can arise by accident when an investor has borrowings (perhaps for the purchase of a home or as part of a geared investment strategy), while at the same time the investor or their spouse also holds significant savings (perhaps as term deposits). The investor would normally gain by using the funds in the term deposit to reduce the borrowings (but may choose not to use the savings if they were held for a specific short-term goal). The decision whether to use savings in this way should be based on the comparison of the cost of the borrowings (after tax if the interest is deductible) with the (after-tax) interest received on the investment. As a general rule, a couple should not, between them, hold funds in a low interest rate investment while also having borrowings at a higher (after-tax) interest rate.

¶11-500 CGT trap on retirement There may be some CGT consequences resulting from the use of debt or a gearing strategy to accumulate funds for retirement. While gearing into growth investments such as shares and property is effective in creating wealth for investors while they are working and receiving secure income, the CGT liability arising on the disposal of these assets also needs to be considered. This should be compared to the tax consequences arising out of other wealth creation options, such as superannuation or employee share schemes. For a couple, negatively geared investments will generally be held in the name of the partner who has the higher taxable income. After retirement the investor is likely to pay no income tax or at least a lower rate of tax as taxable salary has ceased and superannuation benefits will be tax-free after age 60. As a result, the after-tax cost of debt will increase and the investor’s focus will change from wealth creation to securing income from the investments. For tax reasons non-superannuation income in retirement should be split between the two partners. Thus, when approaching and/or reaching retirement: • debt would normally be repaid • gearing would be reduced or avoided • some investments would be switched from growth investments to income-based investments • the ownership of the investments should allow non-superannuation income to be split between the partners, and • some or all non-superannuation investments would be transferred (if possible) or realised and contributed to superannuation.

If the gearing strategy has worked well, a significant part of the growth in the value of the investments held at retirement will be payable as CGT if the investments are realised in order to repay the loan, to change ownership, to transfer or contribute them to superannuation or to reinvest in a more balanced investment portfolio aimed at producing income. Because of the CGT implications, care is needed to manage the transition of the investment portfolio from one that is appropriate for a working investor or couple to one that is appropriate in retirement. Tax does need to be taken into account in this transition, although it should not dominate the choice of the appropriate strategy and portfolio for retirement. Strategies to minimise tax on the transition should start at least a few years before retirement and are likely to include: • repaying debt over the last few years of work • increasing the superannuation benefit for a lower paid partner using concessional contributions (if not receiving employer support), salary sacrifice, contributions splitting (¶4-260), non-concessional and/or spouse contributions (¶4-275) • repaying debt by cashing out investments or superannuation benefits that are not subject to CGT or other tax, or are subject to lower rates of tax, or • avoiding new geared investments in the name of the taxpayer on a higher marginal tax rate over the years approaching retirement, and instead increasing salary sacrifice or tax deductible concessional contributions to superannuation within the concessional contributions cap, investments held in a family trust or in the name of the partner on a lower marginal tax rate. Capital Gains Tax can also be reduced by making a tax deductible concessional contribution to superannuation, particularly before age 65 or, subject to the work test, after 64 and before age 75. The concessional contribution counts towards the concessional contributions cap of $25,000 (indexed) (¶4230). The concessional contribution will be taxed at 15% within superannuation (30% if taxable income exceeds $250,000) so tax will be reduced if the marginal rate of CGT is greater than 15% or 30% (an example of this is set out at ¶15-050).

¶11-520 Gearing investments in superannuation funds Superannuation funds are able to gear investments by holding the investment in a special purpose trust providing the security for the loan is limited to that particular investment so the lender has no recourse to any other security or guarantee. Details are set out at ¶5-360. The restrictions on the security that can be given for a loan or the guarantees offered within superannuation means that it is unlikely that the gearing within any special investment trust will exceed about 50%. Thus the level of gearing described above and in the projections is not available to superannuation funds. There are, however, a number of other ways in which a superannuation fund’s investment in Australian shares can be geared in order to enhance the investment return without the owner of the shares having any direct borrowing. These are described at ¶11-600 and following. Projections A number of projections are set out in detail in ¶11-550. Two of these projections, Residential Property and Direct Shares (Margin Loan), using the expected projection, can be adapted so as to illustrate the effectiveness of gearing using a special purpose loan arrangement under superannuation. The model used for the projections in ¶11-550 starts with 100% gearing (ie no initial equity). This level of borrowing is unlikely to be available at reasonable rates of interest for the non-recourse loan required under superannuation arrangement so the model has been adapted to start with $200,000 initial equity and $200,000 borrowing (ie 50% gearing) and then has no further investment. It also assumes that the interest rate will be 0.5% higher than assumed in ¶11-550. The projections have been done on three tax rates:

• 15% for a superannuation fund in accumulation phase • 0% for a superannuation fund in pension phase, and • 47% as a comparison to the maximum marginal tax rate (including Medicare Levy) for individuals making the same geared investment without using superannuation. The results of the projections are set out in the following tables: Residential Property Superannuation Fund Pension Phase

Superannuation Fund Accumulation Phase

Individual

0%

15%

47%

$363,797

$347,771

$325,390

6.2%

5.7%

5.0%

Superannuation Fund Pension Phase

Superannuation Fund Accumulation Phase

Individual

0%

15%

47%

$498,495

$457,390

$391,835

9.6%

8.6%

7.0%

Tax rate Net equity at end of Year 10 Yield pa* Direct Shares (Margin Loan)

Tax rate Net equity at end of Year 10 Yield pa*

* Total yield (income and capital gains) to the investor, after income and CGT and after repaying the loan, if the investment was sold at the end of Year 10 based on the investment of $200,000 for the 10-year period.

The superannuation and individual projections set out above use a considerably lower level of gearing than the projections shown in ¶11-550 and the returns are correspondingly lower. However, for this lower level of gearing, which is generally not negatively geared, the lower rates of tax under superannuation mean that gearing within superannuation does give a better return than an individual on a higher marginal tax rate using the same level of gearing. The projections in ¶11-550 based on 100% gearing show a yield of 11.1% pa for the residential property and 16.7% pa for direct shares for the investment of $75,000 over the 10-year period. Refer to ¶11-550 for full details.

¶11-550 Geared investment projections Set out below are charts showing the results of 10 projections based on a total investment of $400,000, exploring a range of investment options. Further details of the projections, the assumptions used and the results are set out at ¶11-900. The projections are: • investment: – residential property – listed property trusts using a standard margin lending arrangement – direct Australian shares using a standard margin lending arrangement – managed fund (unit trust) investing in Australian shares using a standard margin lending arrangement, or – managed fund (unit trust) investing in international shares using a standard margin lending arrangement.

• interest rate on the borrowings and rates of investment income (dividends or rent) and capital gains: – remain in line with normal expectations over the term of the projection, or – suffer a downturn at the start of Year 4 when interest rates increase by 2% and, as a result, a correction takes place whereby market values and the investment income reduce by 10%; this has the effect of an overall growth rate in Year 4 of −6.4% for residential property, −7.75% for listed property trusts, −6.4% for Australian shares, −7.75% for managed funds (Australian shares) and −6.85% for managed funds (international shares). In the projections, the net equity figure at the end of Year 3 includes the 10% reduction in market values assumed to take place at the start of Year 4. The projections are based on the initial investment being funded entirely by borrowed funds; there is no initial equity. An amount of $7,500 is contributed each year, which is used to pay for some of the interest. This contribution, which totals $75,000 over 10 years, represents the equity invested. Cash flow, after tax, has been used to repay the loan if positive, or has been made up by increasing the loan if negative. The projections, then, assume that the investor invests $75,000 over 10 years and receives the final proceeds after any CGT liability has been met, the loan repaid and the arrangement has been wound up. The yield per annum has been calculated on this basis. Where after-tax cash flow is positive, this has been used in the projections to reduce the loan, which reduces the level of gearing. If the income from the investment, after tax, is reinvested and/or the interest on the loan capitalised, this will retain a higher level of gearing, or even lead to an increased level of gearing. As with any gearing, an increased level of gearing will increase returns from favourable investments and reduce returns or increase losses from unfavourable investments. An increase in gearing will not turn a poor investment into a good one. For an increase in gearing to improve the return from an investment, the after-tax return from the investment funded by the increase in gearing must exceed the after-tax cost of the increase in borrowing, after all expenses have been taken into account. If investment income is reinvested, care will be needed to ensure that any tax payable on the investment income is not paid by an increase in the loan, as this could compromise the deductibility of interest on the loan. Interest on funds borrowed to pay tax would not, normally, be a tax deduction to an individual. The projections assume a 50% reduction in CGT and a full refund of any excess franking credits. Franking credits are based on a 30% company tax rate. The financial assumptions are designed to be long-term rates appropriate for a 10-year projection. They are based on inflation of 2.5% which is the mid-point of the RBA’s target range and a cash rate of 3.5% which represents a neutral setting by the RBA. Currently, inflation and interest rates are at historically low levels and look likely to remain stable in the short term, with some expectations of inflation hitting the RBA target of 2.5% in the short to medium term. Investment returns in recent years have included a boom in prices for residential property; however, most recently, the residential property market is seeing a correction of prices and together with the COVID-19 crisis analysts are expecting property process to fall again. The property market takes longer to show impact, so the effects remain to be seen; however, short-term falls in the property market are expected. The assumptions used in this chapter are based on more “normal” or longer-term conditions, rather than focusing on short-term cyclical changes in projections. Other assumptions used in the projections include: • tax deferred income — 5% of income for residential property, 40% for listed property trusts • franking — 80% of income for direct Australian shares, 50% for managed funds (Australian shares) • realised capital gains held for at least 12 months — 40% of income for managed funds (Australian shares), 80% for managed funds (international shares). Property projections

After-tax cash flow Residential Property

Listed property trusts

Expected

Downturn

Expected

Downturn

Year 1

$111

$111

$6,626

$6,626

Year 2

$413

$413

$7,360

$7,360

Year 3

$739

$739

$8,139

$8,139

Year 4

$1,089

−$3,975

$8,964

$3,117

Year 5

$1,465

−$3,867

$9,838

$3,710

Year 6

$1,869

−$3,741

$10,765

$4,347

Year 7

$2,303

−$3,596

$11,746

$5,031

Year 8

$2,767

−$3,432

$12,784

$5,764

Year 9

$3,264

−$3,245

$13,882

$6,551

Year 10

$3,795

−$3,036

$15,044

$7,394

Net equity Residential Property

Listed property trusts

Expected

Downturn

Expected

Downturn

Year 1

−$11,887

−$11,887

$9,060

$9,060

Year 2

$2,904

$2,904

$22,048

$22,048

Year 3

$15,833

−$21,019

$35,969

$3,344

Year 4

$29,606

−$9,960

$50,874

$11,696

Year 5

$44,269

−$1,008

$66,816

$20,784

Year 6

$59,870

$7,509

$83,852

$30,655

Year 7

$76,461

$16,666

$102,043

$41,362

Year 8

$94,093

$26,504

$121,449

$52,957

Year 9

$112,825

$37,065

$142,137

$65,499

Year 10

$132,714

$48,394

$164,175

$79,050

Total return (income and capital gains) to the investor, after expenses, income tax and CGT and after repaying the loan, if the investment was sold at the end of Year 10 Residential Property

Net equity at end of Year 10 Yield pa

Listed Property Trusts

Expected

Downturn

Expected

Downturn

$132,714

$48,394

$164,175

$79,050

11.1%

−9.1%

15.1%

1.0%

Comments Residential property The returns are quite good on residential property, provided the expected rates of capital growth are achieved; however, the after-tax cash flows are only positive because of the $7,500 invested each year. The investment shows a significant loss with the downturn. Prices for residential property are cyclical, typically with a 5- to 10-year cycle, and the actual parts of the cycle experienced by the investor will determine whether or not the investment is profitable. Listed property trusts Listed property trusts give a better return than residential property. After-tax cash flow, after allowing for the $7,500 invested each year, is positive from Year 3 on the expected basis but not with the downturn. Listed property trusts have been shown to be quite a volatile investment in recent years, in part because of their internal gearing, although their internal gearing has been reduced in recent years. Overall, gearing into listed property trusts represents a high level of gearing. Share projections Direct Shares (Margin Loan)

After-tax cash flow Direct Shares (MarginLoan) Expected

Downturn

Year 1

$811

$811

Year 2

$1,301

$1,301

Year 3

$1,833

$1,833

Year 4

$2,407

−$3,065

Year 5

$3,028

−$2,780

Year 6

$3,698

−$2,461

Year 7

$4,419

−$2,105

Year 8

$5,197

−$1,708

Year 9

$6,032

−$1,269

Year 10

$6,930

−$783

Net equity Direct Shares (MarginLoan) Expected

Downturn

Year 1

$9,902

$9,902

Year 2

$23,836

$23,836

Year 3

$38,817

$4,739

Year 4

$54,910

$13,873

Year 5

$72,183

$23,790

Year 6

$90,707

$34,542

Year 7

$110,560

$46,190

Year 8

$131,820

$58,795

Year 9

$154,573

$72,424

Year 10

$178,908

$87,147

Total return (income and capital gains) to the investor, after expenses, income tax and CGT and after repaying the loan, if the investment was sold at the end of Year 10 Direct Shares (Margin Loan)

Net equity at end of Year 10 Yield pa

Expected

Downturn

$178,908

$87,147

16.7%

3.0%

Australian share trust and international share trust

After-tax cash flow Australian share trust

International share trust

Expected

Downturn

Expected

Downturn

Year 1

$5,626

$5,626

$2,340

$2,340

Year 2

$6,289

$6,289

$2,898

$2,898

Year 3

$6,992

$6,992

$3,497

$3,497

Year 4

$7,738

$1,964

$4,140

−$1,431

Year 5

$8,529

$2,467

$4,830

−$1,063

Year 6

$9,368

$3,009

$5,569

−$659

Year 7

$10,256

$3,591

$6,360

−$215

Year 8

$11,197

$4,217

$7,206

$270

Year 9

$12,192

$4,888

$8,111

$801

Year 10

$13,246

$5,609

$9,077

$1,380

Net equity Australian share trust

International share trust

Expected

Downturn

Expected

Downturn

Year 1

$11,842

$11,842

$11,527

$11,527

Year 2

$26,075

$26,075

$25,519

$25,519

Year 3

$41,222

$5,084

$40,511

$6,084

Year 4

$57,331

$16,737

$56,559

$15,923

Year 5

$74,455

$27,904

$73,727

$25,842

Year 6

$92,646

$38,731

$92,078

$36,559

Year 7

$111,961

$50,348

$111,681

$48,129

Year 8

$132,458

$62,803

$132,608

$60,608

Year 9

$154,199

$76,149

$154,934

$74,057

Year 10

$177,249

$90,440

$178,740

$88,539

Total return (income and capital gains) to the investor, after expenses, income tax and CGT and after repaying the loan, if the investment was sold at the end of Year 10 Australian shares trust

Net equity at end of Year 10 Yield pa

International shares trust

Expected

Downturn

Expected

Downturn

$177,249

$90,440

$178,740

$88,539

16.5%

3.7%

16.6%

3.3%

Comments Direct Shares (Margin Loan), managed fund (Australian shares) and managed fund (international shares) All these investments give good returns with after-tax cash flows on the expected basis increasing steadily. For the Australian share trust, the income received is quite high and includes tax advantages. This more than compensates for the higher interest rate assumed for the margin lending used. Even the modest rates of capital growth achieved over the 10 years with the downturn are sufficient to give a positive, but small, investment return. Direct shares remain negatively geared with the downturn but also show a small positive investment return.

OTHER FORMS OF GEARED INVESTMENTS ¶11-600 Geared share managed funds A few fund managers offer managed funds that invest in Australian shares or international shares, with the managed funds including borrowings to produce a geared investment. Set out below is a simple example based on: • 6% interest on borrowings (the fund is able to borrow on the wholesale market at low rates) • investment in Australian shares with a dividend yield of 4% • gearing of 50%. Example The unitholder invests $100 in the fund. The fund borrows another $100. The fund uses the $200 to buy shares. If the shares increase in value by 10%, their value would be $220. As the loan is still $100, the value of the units has increased to $120, ie a 20% increase. If the value of the shares reduces by 10%, the value of the units reduces by 20%. During the year dividends would be $8 (4% × $200). Interest on the loan would be $6 (6% × $100), leaving $2 to be distributed to unitholders. The franking credits attached to the total dividends received of $8 would also be distributed to the unitholders.

Two aspects of Australian taxation place constraints on the operation of trusts (such as managed funds): • a trust cannot distribute a loss, it is carried forward and offset against future income. Thus, the tax deduction against other income, which is a major attraction of negative gearing, is not available to investors in a geared trust or managed fund

• franking credits can only be distributed to investors if the dividends and other income received by the trust exceeds interest and other expenses charged against income so that the trust can distribute taxable income. Otherwise, the franking credits would be lost — significantly reducing the return from investing in Australian shares. For example, these constraints have led one fund manager to limit gearing under their managed funds as follows: • the international fund has gearing fixed at a modest level of 33⅓% • the Australian share fund aims to meet borrowing costs from net dividend income, so gearing (the ratio of borrowing to total fund assets) will vary from time to time, reflecting the ratio of interest rates to net dividend income. Gearing will generally be in the range of 40%–60%. A geared managed fund offers easy access to a geared investment with its tax and investment advantages. It also offers a low interest rate on the borrowings and is available to superannuation funds. However, the level of gearing is determined by the fund manager, not the investor and is lower than would be the case for a negatively geared investment. These managed funds offer a geared investment in shares in a similar way to listed property trusts and property syndicates, which offer geared investment in property.

¶11-650 Options offered by companies Some companies have options as well as shares listed on the Australian Stock Exchange. Holders of options have the right (but not the obligation) to purchase shares on the terms set out at the time the options were issued. If a company’s shares are selling for $5, an option to purchase the shares for $3 would sell for about $2 (in practice the price is likely to be a little higher because the future payment will be discounted for the interest saved less dividends forgone). If the price of the shares increased to $5.50, the price of the option would increase to $2.50. A 10% increase in the share price would give a 25% increase in the price of the option. Similarly, a reduction in the share price of 10% to $4.50 would reduce the price of the option by 25% to $1.50. Options represent a geared investment as any change in the value of the underlying share will be increased or geared up under the option. Some general comments about options are as follows: • only a few companies have options available so the choice of investment is quite limited • options do not receive the dividends which are paid to ordinary shares • if the share price drops to below the exercise price, the option would become worthless and the investor would lose the amount invested. However, there is no continuing liability as there is no loan to be repaid • in many cases the investor does not have any control over the date at which the options can be exercised, this being at the discretion of the company.

¶11-700 Instalment warrants An instalment warrant is an option to buy shares in a company (normally a larger company) listed on the Australian Stock Exchange. However, whereas an option is issued by the company itself, a warrant is issued by a financial institution. It is traded on the Australian Stock Exchange. Instalment warrants typically: • are issued at a price which is about half the price of the underlying share • have a term of about 18 months

• have an exercise price (second instalment) which is a little more than the issue price so the total cost is higher than the cost of the underlying share • entitle the holder to any dividends and possibly franking credits • are settled for shares rather than cash on expiry. Instalment warrants represent a means of purchasing a portfolio of shares “by instalments” as the purchase cost is spread over two payments about 18 months apart. However, the interest rate and expenses implicit in the costing need to be weighed against the benefits of the arrangement and compared to alternative means of purchasing shares. During the period before the second instalment is paid, an instalment warrant represents a geared investment as any change in the value of the underlying share will be increased or geared up under the warrant. Shares already held in the portfolio can be converted to instalment warrants and this would generate funds to diversify the portfolio (or for other purposes) without selling the share and incurring CGT. This can be attractive where there are significant unrealised capital gains. Instalment warrants can allow a superannuation fund to access geared investments. However, a superannuation fund is not permitted to convert existing shares into instalment warrants (¶9-340).

¶11-750 Endowment warrants Endowment warrants are set up to run for 10 years on the basis that the initial cost covers only part of the cost price of the underlying share. The sponsor of the warrant borrows the balance of the cost price of the share plus an additional amount to cover expenses. The amount borrowed is called the outstanding amount and interest is charged on this borrowing. As dividends are received they are used to pay the interest with any excess being used to reduce the outstanding amount. In some cases, the value of any franking credits will also reduce the outstanding amount. Endowment warrants are designed so that the dividends (and franking credits, if appropriate) will pay the interest and repay the outstanding amount at the end of the 10-year term. If dividends are higher than expected, or interest rates are lower than expected, the outstanding amount will be repaid before 10 years and the shares will be transferred to the warrant holder. However, if dividends or interest are less favourable than expected, there will still be a balance outstanding when the warrant expires at the end of the 10-year period. The outstanding amount could then be paid and the shares transferred to the holder. Alternatively, some of the warrants could be sold and the proceeds used to pay the outstanding amount on the balance of the warrants held. The shares represented by the warrants would be transferred to the holder of the warrant. Endowment warrants represent a convenient way of making a geared investment in Australian shares as the investment can be made in small quantities. The investor does not have to arrange any direct borrowing and is not responsible for the borrowing. However, the convenience comes at a price, as the financial institutions who sponsor the warrants charge expenses, and these need to be weighed against the convenience. Endowment warrants provide an investment return in the form of changes in the capital value, they do not pay any income as this is used to pay interest and repay the outstanding amount.

¶11-800 Exchange traded options and share futures There are a number of exchange traded options and share futures which are listed on the Australian Stock Exchange. These are based on shares in individual companies (normally larger companies) or a share index and cover periods up to about 18 months. Exchange traded options and warrants can represent a geared investment in the underlying company or index. Exchange traded options and warrants: • are usually settled on expiry for cash, which has to be reinvested

• do not receive dividends • receive profits from short-term trading rather than a long-term investment in the underlying company. Because of their short-term trading nature, these options and futures are fundamentally different to the gearing and negative gearing discussed above, which are a long-term means of investment aimed at creating wealth, with investments being made on a buy-and-hold basis.

¶11-900 Full details of projections Full details of the projections shown in the charts in ¶11-550, the assumptions used and the results are set out below. The projections show the investor’s total cash flow over the 10-year period (including the $7,500 contribution), both before and after tax, and the return to the investor (after paying CGT and repaying the loan) if the investment was sold at the end of Year 10. Property projections Residential Property

Listed property trusts

Expected

Downturn

Expected

Downturn

Cost of initial investment

$400,000

$400,000

$400,000

$400,000

Opening loan value

$400,000

$400,000

$400,000

$400,000

$7,500

$7,500

$7,500

$7,500

2.5%

2.5%

2.5%

2.5%

4%

4%

0.5%

0.5%

3.5%

3.5%

6%

6%

—

—

—

—

Company tax rate

30%

30%

30%

30%

Tax deferred income

5%

5%

40%

40%

Realised capital gains in income

—

—

—

—

Capital growth Years 1 to 3

4%

4%

2.5%

2.5%

Capital growth Year 4

4%

−6.4%

2.5%

−7.75%

Capital growth Years 5 to 10

4%

4%

2.5%

2.5%

Interest rate Years 1 to 3

7%

7%

8.5%

8.5%

Interest rate Years 4 to 10

7%

9%

8.5%

10.5%

Sale expenses

3%

3%

0.5%

0.5%

47.0%

47.0%

47.0%

47.0%

Total income received after expenses

$161,621

$149,661

$267,543

$248,134

Interest paid

−$276,683

−$342,391

−$305,564

−$368,152

Funds contributed

$75,000

$75,000

$75,000

$75,000

Cash flow before tax

−$40,062

−$117,730

$36,980

−$45,018

Assumptions

Funds invested each year Inflation Acquisition costs Income after expenses Franking

Tax rate Total cash flows Years 1 to 10 (i)

Tax payable

$57,877

$94,100

$68,168

$103,058

After-tax cashflow

$17,815

−$23,630

$105,147

$58,039

Cost base

$391,919

$392,517

$292,983

$300,746

Sale price

$552,245

$497,020

$506,939

$456,245

Taxable gain

$80,163

52,252

$106,978

$77,749

CGT

−$37,677

−$24,558

−$50,280

−$36,542

Sale proceeds after tax

$514,568

$472,462

$456,659

$419,703

Loan balance

−$381,855

−$424,068

−$292,484

−$340,653

Net equity

$132,714

$48,394

$164,175

$79,050

Yield pa (ii)

11.1%

−9.1%

15.1%

1.0%

Net equity at end of Year 10

(i) Total income received after expenses, interest paid, funds contributed, cash flow before tax, tax payable and after-tax cash flow are total figures over 10 years. (ii) Total return (income and capital gains) to the investor, after income and CGT and after repaying the loan, if the investment was sold at the end of the year. Direct Shares (Margin Loan) Direct Shares (Margin Loan) Expected

Downturn

Cost of initial investment

$400,000

$400,000

Opening loan value

$400,000

$400,000

$7,500

$7,500

Inflation

2.5%

2.5%

Acquisition costs

0.5%

0.5%

Income after expenses

4%

4%

Franking

80%

80%

Company tax rate

30%

30%

Tax deferred income

—

—

Realised capital gains in income

—

—

Capital growth Years 1 to 3

4%

4%

Capital growth Year 4

4%

−6.4%

Capital growth Years 5 to 10

4%

4%

Interest rate Years 1 to 3

8.5%

8.5%

Interest rate Years 4 to 10

8.5%

10.5%

Sale expenses

0.5%

0.5%

Tax rate

47.0%

47.0%

Assumptions

Funds invested each year

Total cash flows Years 1 to 10 (i) Total income received after expenses

$191,142

$176,998

Interest paid

−$330,909

−$398,486

Funds contributed

$75,000

$75,000

Cash flow before tax

−$64,767

−$146,488

Tax payable

$100,424

$136,262

After-tax cash flow

$35,657

−$10,226

Cost base

$400,000

$400,000

Sale price

$586,206

$527,586

Taxable gain

$93,103

$63,793

CGT

−$43,758

−$29,983

Sale proceeds after tax

$542,448

$497,603

Loan balance

−$363,540

−$410,456

Net equity

$178,908

$87,147

Yield pa (ii)

16.7%

3.0%

Net equity in Year 10

(i) Total income received after expenses, interest paid, funds contributed, cash flow before tax, tax payable and after-tax cash flow are total figures over 10 years. (ii) Total return (income and capital gains) to the investor, after income and CGT and after repaying the loan, if the investment was sold at the end of the year. Manager fund (Australian share trust) and managed fund (international share trust) Managed fund (Australian shares)

Managed fund (international shares)

Expected

Downturn

Expected

Downturn

Cost of initial investment

$400,000

$400,000

$400,000

$400,000

Opening loan value

$400,000

$400,000

$400,000

$400,000

$7,500

$7,500

$7,500

$7,500

Inflation

2.5%

2.5%

2.5%

2.5%

Acquisition costs

0.5%

0.5%

0.5%

0.5%

Income after expenses

5.5%

5.5%

4.5%

4.5%

Franking

50%

50%

—

—

Company tax rate

30%

30%

30%

30%

—

—

—

—

Realised capital gains in income

40%

40%

80%

80%

Capital growth Years 1 to 3

2.5%

2.5%

3.5%

3.5%

Capital growth Year 4

2.5%

−7.75%

3.5%

−6.85%

Capital growth Years 5 to 10

2.5%

2.5%

3.5%

3.5%

Assumptions

Funds invested each year

Tax deferred income

Interest rate Years 1 to 3

8.5%

8.5%

8.5%

8.5%

Interest rate Years 4 to 10

8.5%

10.5%

8.5%

10.5%

0%

0%

0%

0%

47.0%

47.0%

47.0%

47.0%

Total income received after expenses

$245,248

$227,456

$210,115

$194,666

Interest paid

−$310,294

−$373,797

−$324,218

−$390,478

Funds contributed

$75,000

$75,000

$75,000

$75,000

Cash flow before tax

$9,954

−$71,341

−$39,103

−$120,812

Tax payable

$81,478

$115,994

$93,130

$128,629

After-tax cash flow

$91,432

$44,653

$54,027

$7,817

Cost base

$400,000

$400,000

$400,000

$400,000

Sale price

$509,486

$458,538

$561,432

$505,289

Taxable gain

$54,743

$29,269

$80,716

$52,645

CGT

−$25,729

−$13,756

−$37,937

−$24,743

Sale proceeds after tax

$483,757

$444,781

$523,496

$480,546

Loan balance

−$306,508

−$354,342

−$344,756

−$392,007

Net equity

$177,249

$90,440

$178,740

$88,539

Yield pa (ii)

16.5%

3.7%

16.6%

3.3%

Sale expenses Tax rate Total cash flows Years 1 to 10 (i)

Net equity in Year 10

(i) Total income received after expenses, interest paid, funds contributed, cash flow before tax, tax payable and after-tax cash flow are total figures over 10 years. (ii) Total return (income and capital gains) to the investor, after income and CGT and after repaying the loan, if the investment was sold at the end of the year.

FAMILY HOME The big picture

¶12-000

Home ownership Home ownership in Australia

¶12-005

Home ownership strategies

¶12-010

Tax and the family home CGT and the family home

¶12-050

CGT consequences when person ceases to be an Australian resident ¶12-051 CGT consequences when person disposes of home

¶12-052

Main residence CGT exemption

¶12-053

Home used for income-producing purposes

¶12-056

Taxes imposed on resident non-occupying owners Land tax

¶12-057

Other taxes imposed on absentee owners

¶12-058

Deductibility of home expenditure Establishing a home office

¶12-060

A place of business or a place of convenience

¶12-062

Deductions for home office expenses

¶12-065

Calculating occupancy costs and running costs

¶12-066

Deductibility of work-related expenses when you have a home office

¶12-068

Taxes on foreign residents CGT withholding tax

¶12-070

When must tax be withheld, and claiming the credit

¶12-071

Clearance certificate

¶12-072

Additional taxes on foreign resident owners

¶12-075

GST implications GST and the family home

¶12-080

GST and acquisition of the family home

¶12-081

GST and sale of the family home

¶12-082

GST and renovations/repairs to the family home

¶12-083

GST and renting the family home

¶12-084

Government grants and assistance Concessions for the family home

¶12-090

First home owner’s grant

¶12-091

Additional benefits for first home owners

¶12-092

Other benefits for home owners

¶12-096

First home loan deposit scheme

¶12-097

First home super saver scheme

¶12-098

Acquisition/construction of family home Structuring the acquisition of the family home

¶12-100

Financing the acquisition/construction of a home

¶12-110

Main residence exemption for homes that are constructed

¶12-120

Family breakdown and the family home Consequences of property settlement

¶12-200

Marriage breakdown CGT rollover relief

¶12-210

Where CGT rollover may not be appropriate

¶12-215

Renting out the home Renting out the whole or part of the home

¶12-300

Taxation implications of Airbnb

¶12-350

Disposal Consequences arising from disposal of family home

¶12-500

Home acquired with intention of selling at a profit

¶12-510

Main residence exemption

¶12-580

Dwelling not originally established as main residence

¶12-590

Dwelling originally used as main residence

¶12-600

Delay in moving into a dwelling

¶12-620

Changing main residences

¶12-630

Absences from main residence

¶12-640

Main residence exemption exclusion for foreign residents

¶12-645

Destruction of dwelling and sale of land

¶12-650

Adjacent land sold separately

¶12-670

Spouse or child chooses a different main residence

¶12-680

Retirement and the family home

¶12-700

Superannuation benefits for downsizing

¶12-710

Consequences of death on family home

¶12-800

¶12-000 Family home

The big picture Home ownership • The family home is one of the most common assets in Australia. The questions to be asked before buying a home are discussed .................................... ¶12-005

• A variety of strategies can be adopted in relation to the family home .................................... ¶12010 Tax and the family home • One of the great advantages of the family home is that it is generally exempt from tax when sold. The capital gains tax (CGT) main residence exemption and some exceptions to the general rule need to be considered when buying or selling a home .................................... ¶12-050 • Taxes and levies may be imposed on owners of property in Australia that do not occupy their premises .................................... ¶12-057 • People are increasingly using their homes as a place of work/business. There are potential CGT consequences from such utilisation.................................... ¶12-060 • There are income tax deductions available for people using their homes for income-producing purposes .................................... ¶12-065 • The sale of a home in Australia with a value in excess of a specific threshold is subject to a nonfinal CGT withholding on its value unless an Australian Taxation Office (ATO) clearance certificate is obtained evidencing the seller is an Australian resident .................................... ¶12070 • Additional taxes may be imposed on foreign residents buying or owning residential property in Australia .................................... ¶12-075 • The goods and services tax (GST) will have many consequences for the family home .................................... ¶12-080 Government grants and assistance • The government in the relevant states and territories provide certain grants and concessions for people buying their first home or a new home .................................... ¶12-090 • The federal, state and territory governments have a range of concessions and grants available for home buyers and renovators .................................... ¶12-096 • The federal government has a First Home Loan Deposit Scheme to assist in the purchase of a first home .................................... ¶12-097 • The federal government has a First Home Super Saver (FHSS) scheme to encourage saving through voluntary superannuation contributions for the purpose of acquiring a first home .................................... ¶12-098 Acquisition/construction of family home • The acquisition of the family home can be structured in a variety of ways. In this context, the attitude of the ATO towards certain home loan products should be considered .................................... ¶12-100 Family breakdown and the family home • The major asset in many family breakdowns is the family home. There is a range of structures that can be utilised to achieve certain taxation and other outcomes in the event of a family breakdown .................................... ¶12-200 Renting out the whole or part of the home • CGT and other consequences arise when a part or the whole of the family home is rented out .................................... ¶12-300

• There are various taxation considerations for the renting out of a property for short stays in the sharing economy such as Airbnb .................................... ¶12-350 Disposal, retirement and death • The disposal of the family home may have a range of taxation consequences, many related to the uses that the family home has been put to .................................... ¶12-500 • There are consequences associated with owning a family home when a person faces retirement. Reverse mortgages are a popular way to fund retirement .................................... ¶12-700 • The family home is often one of the assets owned by a deceased person. The consequences for the beneficiary under the will vary depending on the use made of the family home .................................... ¶12-800

HOME OWNERSHIP ¶12-005 Home ownership in Australia Ever since strata title ownership was introduced in the 1960s, the idea of home ownership as the essential ingredient in pursuing the “Great Australian Dream” has largely gone unchallenged. However, in recent times, the publication of data on the changing trends in home ownership has fuelled a debate on what is the best strategy in regard to home ownership. It is likely that more and more clients will be asking questions such as the following: • Should I use all my disposable income to pay off my mortgage? • Should I purchase a home now or later? • Is it really a good idea to rent rather than buy? • If I do not buy a home now, how can I be financially secure? • Should I enter into a reverse mortgage? • Should I sell my home and put the proceeds into a superannuation fund? In the past, according to conventional wisdom, the best strategy was to buy your own home as soon as possible and the majority of a family’s income was then applied to paying off the mortgage. However, in recent years there is a noticeable trend for younger households to rent rather than buy. This is largely due to the increased house prices. In this manner, the different strategies for obtaining home ownership and optimising it as future investment are important.

¶12-010 Home ownership strategies The most important point to make is that there is not one single correct strategy for acquiring a home or investing for the future. However, it is likely that, in the future, the financial planner will be increasingly called on to provide clients with guidance and advice as to appropriate home ownership strategies. This might require the financial planner to evaluate the various options that are available to clients. These options essentially fall into the following categories: • purchase a main residence and channel any spare disposable income (in excess of minimum mortgage repayments) into paying off the mortgage. A sub-strategy could then be to: – sell the home at retirement age and buy or rent cheaper accommodation

– invest the remaining proceeds in high-yielding securities • rent now and save for a more substantial deposit, ie postpone the purchase of a main residence • rent and invest funds in shares and/or managed investments • rent and buy an investment property for negative gearing purposes • rent and spend on a better lifestyle and then rely on superannuation savings. Being aware of the main advantages and disadvantages associated with home ownership will assist you in guiding clients through the various options they might be considering. Advantages of home ownership • Provides people with stability (renting involves uncertainty as the owner might sell the premises). • Avoids the stigma that some people might feel is attached to not buying a home. • Choice of lifestyle where wealth creation is not the primary motivation. • Freedom to make personal changes to the residence. • No capital gains tax (CGT) generally applies to the main residence. • Improvements are not subject to CGT. • Paying off a mortgage is a form of disciplined saving. • Further improvements to the main residence could be a good strategy for a client who already has substantial superannuation assets. • A potential first home owner choosing not to buy will forgo the grants and other concessions available for first home buyers (¶12-090). Disadvantages of home ownership • Property prices can go down as well as up — in order to reap capital profits, it is essential to pick the right property. • Demand for property (and therefore price) may be lower in the future due to the following factors: – less immigration, which means lower population growth – low inflation, which eliminates the potential for high capital profits – more and more people deferring the purchase of the first home – increases in unemployment rates. • The associated costs of buying and selling a property are often ignored when calculating overall returns. The costs include legal fees, stamp duty on purchase, loan application fees, insurance, council rates, interest, maintenance and renovation costs and agent’s commission. Such costs often substantially reduce the real capital growth on property. • There is an opportunity cost in that funds are not available for investment in other areas which might have the potential for higher returns. • Lack of diversification of assets. • Property is often not the best investment in retirement as a client’s major objective changes from

maximising capital growth (during the asset accumulation phase) to maximising income in retirement. • Even though CGT does not apply to the main residence, often the tax concessions that are available at the outset, and throughout the life, of an alternative investment are more significant to the wealth creation potential (eg negative gearing is such a powerful investment tool because Australian residents are able to claim deductions for the interest incurred on loan funds to acquire the property and enjoy the benefit of the 50% CGT discount that applies to assets held by residents for at least 12 months). In addition, there are tax benefits that may be obtained through superannuation strategies. • Property is an illiquid asset.

TAX AND THE FAMILY HOME ¶12-050 CGT and the family home The CGT provisions are triggered when a CGT event occurs. In relation to the family home, these events are: • where a person ceases to be an Australian resident (¶12-051), or • where a person disposes of the home (¶12-052). It is usually the case that the sale of the family home will be exempt from CGT consequences. This exemption is referred to as the “CGT main residence exemption” (¶12-053). However, in some situations the sale of the family home will result in a CGT liability. For example, where the family home is sold at the time the person is a foreign resident for tax purposes, the main residence exemption is generally not available (¶12-645). The special rules relating to the CGT consequences for deceased estates are dealt with at ¶19-150 and following. The CGT withholding rules in ¶12-070 have to be considered where there is a sale of taxable Australian real property.

¶12-051 CGT consequences when person ceases to be an Australian resident Where a person ceases to be an Australian resident, there will not be a capital gain or loss on the family home if it is located in Australia as a result of the cessation. This is because real estate in Australia constitutes taxable Australian real property. Where the family home is located outside Australia and the owner ceases to be an Australian resident, the owner is deemed to have disposed of the home at that time giving rise to a capital gain or loss equal to the difference between the market value of the home at that time and its relevant cost base (subject to the main residence exemption: ¶12-053) unless: • the family home was acquired before 20 September 1985, or • the person was only a temporary resident before ceasing to be a resident. Where the family home is not situated in Australia, the person will need to consider the taxation consequences resulting from the deemed disposal. Where a capital gain arises because the person ceases to be a resident, the taxpayer may choose to disregard the capital gain on the cessation of residency and only pay CGT when the home is ultimately sold and funds are available to pay the tax liability. To make such a choice, the taxpayer must choose to disregard the capital gain or loss from the deemed disposal of all the taxpayer’s CGT assets (excluding assets that constitute taxable Australian property) at time of cessation. There is no ability to choose to make the election solely in relation to the family home and exclude all other CGT assets. Where the choice to disregard the capital gain or loss is made, the ultimate capital gain or loss will be based on the actual sale proceeds received, not the market value at the time of ceasing residency.

In deciding whether to make the choice or not the following should be considered from a tax perspective: (a) Main residence exemption The main residence exemption is generally not available to reduce a capital gain on the sale of a property where it is sold while the taxpayer is a foreign resident (¶12-645). Therefore, where the partial or full main residence exemption is available at the time of ceasing to be resident the taxpayer may be entitled to a full exemption, or a significant reduction in the taxable capital gain by choosing to be taxed at that time instead of the later date of sale. (b) CGT general discount The CGT general discount of up to 50% for assets held for at least 12 months will be reduced for any period that the property was held that the taxpayer was a foreign resident or temporary resident since 8 May 2012. In this manner, where it is expected that the family home will significantly increase in value in the future, it may be better to pay the tax on cessation of residency to maximise the available CGT discount and keep any future capital growth out of the Australian tax net. (c) Other CGT assets The taxation implications arising from the property and other CGT assets at the time of the cessation of residency need to be weighed up.

¶12-052 CGT consequences when person disposes of home If a person’s home was acquired before 20 September 1985, no CGT liability should arise when the home is sold. This rule applies regardless of whether or not the home has been used for income-producing purposes, eg where it became a rental property. A CGT liability may arise where certain improvements are made after 19 September 1985 and the home is rented or used for business purposes (see Income Tax Assessment Act 1997 (ITAA97) s 108-70). Even where the home is acquired after 19 September 1985, no CGT liability will generally arise on the sale of a home used solely as the main residence by a tax resident. However, in some situations, such as where part of the home is rented out or used as a place of business, a capital gain or loss may arise when the home is sold. Further, where the taxpayer is a foreign resident at the time of sale, the main residence exemption will generally not be available (¶12-645). A capital gain or loss from the sale of a home (acquired post-CGT) is calculated as follows. STEP 1: Determine the capital gain or loss on the sale of the home in the normal manner (refer to Chapter 2 for how to calculate capital gains and losses). STEP 2: Determine whether and to what extent the exemption in respect of a main residence is available to decrease this capital gain or loss (¶12-053). STEP 3: Decrease the capital gain calculated at Step 1 by the amount of the exemption calculated at Step 2. STEP 4: Where the home has been owned for at least 12 months prior to sale, the CGT general discount may apply to reduce the balance calculated in Step 3 (subject to first applying any current year or prior year capital losses against the balance). A 50% CGT general discount is available for owners that have been residents (other than temporary residents) for the whole period of ownership. This rate is reduced to take into account any part of the ownership period during which the owner was a foreign resident or a temporary resident after 9 May 2012. However, where the owner was either a foreign resident or a temporary resident as at 8 May 2012 and later sells the home owned at that time, the 50% discount will only be available for any capital gain accrued up to 8 May 2012 provided the owner obtains a market valuation of the property as at that date. No discount will be available where the owner was a foreign resident or a temporary resident at all times since 8 May 2012 and no valuation was obtained. The remaining amount (if any) after Step 4 is the net capital gain or loss that arises on the sale of the family home. An individual ceasing to be a resident of Australia should also be aware that a non-final withholding tax

may apply to the proceeds from the sale of a home in Australia (¶12-070).

¶12-053 Main residence CGT exemption It is usually the case that the sale of the family home by a tax resident will be exempt from CGT in accordance with the main residence exemption. In some situations, however, the sale of the family home will result in a CGT liability. The following flowchart and table provide an overview of the CGT main residence exemption.

Is the family home a dwelling? |

YES

NO

▾

▾

Is the family home owned as trustee or beneficiary of a deceased estate?

CGT main residence exemption will not be available.

NO

YES

▾

▾

Is the family home owned by an individual?

See special rules for main residence exemption and deceased estates: ¶12-800

YES

NO

▾

▾

Is the individual a tax resident (ie not a foreign resident) at the time of sale?

CGT main residence exemption not generally available unless owner is a disability trust

YES

NO

▾

▾

For the whole of the ownership period was the family home: – the main residence of the individual, and – not used for income-producing purposes

CGT main residence exemption is generally not available: ¶12-645

YES

NO

▾

▾

Full CGT main residence exemption will apply to the sale of the family home

A partial CGT main residence exemption may be available (¶12-580)

The above summary is subject to the following various rules that either extend or limit the availability of the CGT main residence exemption. Rules that extend the CGT main residence exemption

Rules that limit the CGT main residence exemption

• Delay in moving into a dwelling (¶12-620)

• Adjacent land sold separately (¶12-670)

• Changing main residences (¶12-630)

• Spouse or child chooses a different main residence (¶12-680)

• Absences from the main residence, including use as rental property (¶12-640)

• Foreign residents are generally not entitled to the main residence (¶12-645)

• Destruction of dwelling and sale of land (¶12650)

Tip Notwithstanding the application of the CGT main residence exemption, the seller still needs to consider the potential application of the non-final CGT withholding tax (¶12-070). Unless an exemption applies, CGT withholding tax will be required to be deducted from the sale price.

What is a “dwelling”? A “dwelling” is defined for CGT purposes to include a unit of accommodation that is: • either a building or contained in a building and which consists wholly or mainly of residential accommodation, or • a caravan, houseboat or other mobile home. An underground home such as those found at Coober Pedy will qualify as a dwelling, but an insubstantial structure such as a tent does not. The CGT main residence exemption also extends to land adjacent to the dwelling where the following criteria have been satisfied: • the land is adjacent to the dwelling • the land is sold at the same time as the dwelling • the combined area of the land on which the dwelling is situated and the adjacent land does not exceed two hectares

• the adjacent land was used primarily for private or domestic purposes in association with the dwelling throughout the period it was owned. There is no statutory guidance as to what is meant by “adjacent” for these purposes. There is no requirement for the adjacent land to be touching either the dwelling or the land on which it is located. A person may acquire the adjacent land for personal use after the time the main residence is acquired and, provided it is sold as part of the same transaction, no capital gain or loss will arise on its disposal. Where the total area of the land on which the dwelling is situated exceeds two hectares, an exemption is only available in respect of two hectares. Therefore, it is necessary to determine the value of the dwelling and surrounding two hectares as that portion of the sale proceeds will be exempt. The balance of the sale proceeds will be used to calculate the CGT liability in respect of the remaining land. Where adjacent land is sold separately from the dwelling, no CGT main residence exemption is available in respect of that land, except where the disposal was made pursuant to a compulsory acquisition or certain other involuntary events. “Main residence” To qualify for CGT exemption, a family home must be a “main residence”. This is a question of fact. The factors the ATO will take into account in determining whether a home is the main residence include: • the length of time the person has lived in the dwelling — there is no minimum time a person has to live in a home before it is considered to be their main residence • the place of residence of the person’s family • whether the person has moved personal belongings into the dwelling • the address to which the person has mail delivered • the person’s address on the electoral roll • the connection of services such as telephone, gas and electricity, and • the person’s intention in occupying the dwelling. In most situations, a dwelling will not be accepted as a taxpayer’s main residence where the taxpayer has never lived in the dwelling. Note that with the exception of a few circumstances (such as changing main residences (¶12-630)) a taxpayer can only have one main residence at a time. Partial CGT exemption In some situations, a taxpayer may be entitled to a partial exemption from CGT on the sale of the family home (¶12-056; ¶12-500). Disposal proceeds as downsizer contributions to superannuation In some situations, a taxpayer may use some of the proceeds from disposing their main residence to make “downsizer contributions” into their superannuation (¶12-710).

¶12-056 Home used for income-producing purposes Home owners may choose to use their family homes for income-producing purposes. This may be done in several ways: • the person rents out the whole or part of their home to another. The consequences arising from this action are outlined at ¶12-300, or • the person uses part of their home for income-producing purposes, such as a home office, doctor’s surgery or other business. The consequences of this action are outlined below.

When a person is considering establishing an office/business at home, the issue arises as to whether they are still entitled to the CGT main residence exemption. The general rules relating to the family home and CGT are discussed above at ¶12-053. If the person’s home was purchased before 20 September 1985, no CGT liability will arise on disposal of the home, regardless of any income-producing use to which it may have been put. Where a home is acquired after 19 September 1985, a subsequent disposal of the home will not give rise to a CGT liability where the full benefit of the CGT main residence exemption applies. The exemption may, however, be reduced where the dwelling is used for income-producing purposes. The reduction in the exemption will be determined on a floor area basis unless the area of the home rented out or used as an office differs significantly in value from the rest of the home. The full CGT main residence exemption may still be available in the following circumstances: • the owner of the home allows other people to share it on the basis that all occupants share household costs • family members or others who share the home pay board, or • the owner maintains a home office purely as a matter of convenience, not as a place of business (¶12-062). Example (1) Dr Walton has owned her home (acquired post-CGT) for 10 years, during the whole of which time she has had a surgery at home. The area of the surgery is 50 m2. The total area of the home is 200 m2. When Dr Walton sells the home, 75% of any resulting capital gain will be exempt from tax and 25% of the gain will be subject to CGT. (2) Assume now that Dr Walton has had a surgery at home for only nine of the past 10 years. The taxable portion of any capital gain made when she sells the home will be calculated as follows:

 9   50  ×  10   200 

× capital gain

It is not possible to retain the full CGT exemption on a home by simply choosing not to claim deductions in respect of any income-producing use of the dwelling.

TAXES IMPOSED ON RESIDENT NON-OCCUPYING OWNERS ¶12-057 Land tax Land tax is an annual tax on the ownership of land. It is imposed by all states and by the Australian Capital Territory. It is usually levied on the unimproved land value. Various exemptions may be available for excluding land tax. The usual exclusion which applies is for an individual that uses their home as the principal residence. Where an individual does not use the property as the principal residence land tax will generally be imposed. A summary of the general land tax imposed on resident individual owners is as follows: State/Territory

Taxable value of land ($)

Land tax payable ($)

New South Wales

Not more than 734,000

Nil

More than 734,000 but not more than 4,488,000

100 + 1.6% of the excess over 734,000

More than 4,448,000

60,164 + 2% of the excess over 4,488,000

Victoria

Queensland

South Australia

Western Australia

Tasmania

Australian Capital Territory

0–249,999

Nil

250,000–599,999

275 + 0.2% of the excess over 250,000

600,000–999,999

975 + 0.5% of the excess over 600,000

1,000,000–1,799,999

2,975 + 0.8% of the excess over 1,000,000

1,800,000–2,999,999

9,375 + 1.3% of the excess over 1,800,000

3,000,000 +

24,975 + 2.25% of the excess over 3,000,000

0–599,999

Nil

600,000–999,999

500 + 1.0% of the excess over 600,000

1,000,000–2,999,999

4,500 + 1.65% of the excess over 1,000,000

3,000,000–4,999,999

37,500 + 1.25% of the excess over 3,000,000

5,000,000–9,999,999

62,500 + 1.75% of the excess over 5,000,000

10,000,000 or more

150,000 + 2.25% of the excess over 10,000,000

0–450,000

Nil

450,001–755,000

0.50 for every 100 (or fractional part) over 450,000

755,001–1,098,000

1,525 + 1.25 for every 100 (or fractional part) over 755,000

1,098,001–1,350,000

5,812.50 + 2.00 for every 100 (or fractional part) over 1,098,000

Above 1,350,000

10,852.50 + 2.40 for every 100 (or fractional part) over 1,350,000

0–300,000

Nil

300,001–420,000

300

420,000–1,000,000

300 + 0.0025 for each $1 over 420,000

1,000,000–1,800,000

1,750 + 0.009 for each $1 over 1,000,000

1,800,000–5,000,000

8,950 + 0.018 for each $1 over 1,800,000

5,000,001–11,000,000

66,550 + 0.02 for each $1 over 5,000,000

11,000,001 +

186,550 + 0.0267 for each $1 over 11,000,000

Less than 25,000

Nil

25,000–349,999.99

50 + 0.55% of the value above 25,000

350,000 +

1,837.50 + 1.5% of the value above 350,000

0–150,000

0.50%

150,001–275,000

750 + 0.60% of value above 150,000

275,001–2,000,000

1,500 + 1.08% of value above 275,000

2,000,001 or more

20,130 + 1.10% of value above 2,000,000

Land tax will also apply to non-resident owners. In some states, the rates of land tax are higher for nonresident absentee owners, trusts and companies. In addition, a surcharge may be imposed on certain foreign resident absentee owners. For more details, see ¶12-075.

¶12-058 Other taxes imposed on absentee owners In addition to land tax, the state of Victoria also imposes a vacant residential land tax on owners of homes in the inner and middle Melbourne area that are unoccupied for more than six months in the preceding calendar year. The tax is imposed at the rate of 1% of the property’s capital improved value. This is distinguished from the land tax absentee owner surcharge, see ¶12-075.

DEDUCTIBILITY OF HOME EXPENDITURE ¶12-060 Establishing a home office When a person is considering establishing an office/business at home, the following issues arise: • whether the home is a “place of business” (¶12-062) • the deductibility of home office expenses (¶12-065) • whether the CGT main residence exemption applies (¶12-053) • the deductibility of work-related expenses (¶12-068) • the effect on pension entitlements (¶12-700 and following). The crucial issue from both a tax and a social security point of view is whether the home office constitutes a “place of business” or is used just as a “place of convenience” to complete work-related or business tasks. If the home office is a place of business — deductions are available for both occupancy and running costs and the full main residence exemption will not be available. It is important to note that, in a situation where the home office is a place of business, it is not possible to retain the full main residence exemption on the home by simply choosing not to claim deductions in respect of the occupancy costs of the home office. Although the taxpayer may potentially be entitled to reduce or eliminate the capital gain on the portion used as a place of business under the CGT small business concessions. If the home office is a place of convenience — deductions are available for running costs only and this use will not prevent the full main residence exemption from applying. This can include working from home as a result of COVID-19 measures.

¶12-062 A place of business or a place of convenience Whether a home office is a place of business or a place of convenience is a question of fact. The following factors are relevant in deciding whether part of the home has been set aside as a place of business: • the area is clearly identifiable as a place of business • the area is not readily suitable or adaptable for private or domestic use in association with the home generally

• the area is used exclusively or almost exclusively for the carrying on of a business, or • the area is used regularly for visits of clients or customers. In situations where the person has no alternative place for undertaking their work, the home office is a place of business if: • it is a requirement inherent in the nature of the person’s activities that they have a place of business • the person’s circumstances are such that there is no alternative place of business and it is necessary to work from home • the area of the home is used exclusively or almost exclusively for income-producing purposes. Here are some examples of the distinction between the home office as a place of business and the home office as a place of convenience. Home office as “place of business”

Home office as “place of convenience”

• A doctor or dentist has a surgery or consulting rooms attached to their residence

• A barrister reads briefs at home

• A tradesperson has a workshop at home

• An employee accountant takes work home at night

• A shopkeeper lives in rooms above the shop

• A teacher prepares lessons and marks assignments at home

• A self-employed scriptwriter uses one room of a flat for writing purposes and for meetings with television staff

• An insurance agent maintains client files and occasionally interviews a client at home

• An employee architect conducts a small practice from home

• An employee works from home as a result of COVID-19 measures

• A country sales manager for an oil company (who is not provided with a place to work) operates mostly out of home

¶12-065 Deductions for home office expenses Deductions where home used as a place of business If a part of the home is used as a “place of business” (¶12-062), a person is entitled to claim a deduction for the proportion of the occupancy and running costs (¶12-066) relating to the business use. See ¶12056 as to when an entitlement to claim deductions for occupancy expenses may also result in a CGT liability when the home is sold. The personal services income regime limits, among other things, the entitlement of some individuals to deductions relating to their personal services income. To the extent that a taxpayer falls within the personal services regime and is not found to be carrying on a personal services business, the taxpayer is not entitled to claim occupancy expenses in respect of a home office. The type of person typically caught by the regime is a taxpayer who primarily undertakes contract work for one entity such that they really are similar to an employee. Deductions where home used as a place of convenience If the part of the home from which income-producing activities occur is used merely as a “place of convenience” (¶12-062), no deduction is allowed for occupancy costs. However, a deduction can be claimed for an appropriate portion of the running costs.

¶12-066 Calculating occupancy costs and running costs

Occupancy costs Occupancy costs are expenses such as rent, mortgage interest, rates, home insurance premiums and repairs. Occupancy costs should generally be apportioned on the basis of floor area and, where the area has not been used for the entire year, on a time basis as well. It will also be necessary to decrease the deduction by the proportion which relates to private use (if any) of the place of business. Running costs Running costs are those costs arising from the use of facilities within the place of business in the home, such as heating, cooling and lighting, depreciation and rental of office furnishings and equipment. Running costs should be apportioned on the basis of private versus work percentage, ie only those costs which are incurred in addition to the normal private costs will be allowable deductions. This means deductions will be available, for example, for electricity only where it relates exclusively to the person’s use while working. If other members of the family are also using the area for private or domestic purposes at the same time, no deduction is available. The deductible amount is equal to the excess of what has been charged over what would have been charged if the person had not been working from home. The following formula is suggested by the ATO to calculate the additional electricity expense for an appliance: A×B×C where: A is the cost per unit of power used B is the average units used per hour C is the total annual hours used for income-producing purposes. Rather than using the above formula, a person may make a bona fide estimate based on a reasonable percentage of the annual household fuel bill. Methods of calculating home office running expenses The ATO outlines the different methods of calculating home office running expenses in Practice Statement PS LA 2001/6 (updated 16 January 2019). The following is a summary of the main issues raised in the Practice Statement. Record-keeping requirements • Taxpayers seeking to claim deductions for home office expenses must be able to prove they have incurred such expenses and must be able to establish a connection between the use of their home office and their work or business. The ATO will accept a diary covering a representative four-week period as establishing a pattern of use for the entire year. This concession was made in order to ease the administrative burden associated with having to keep a complete diary recording the duration and purpose of each use of their home office during the year. The taxpayer may then use the pattern of home office use established during the four-week period to calculate the home office running expenses claim for the entire year, allowing for periods when the home office is not used for income production, such as holidays, illnesses, etc. • A new diary must be kept for each financial year, as patterns of use are likely to fluctuate over two or more years. Employees must keep each of these diaries for five years after lodgment of the return for that year or the due date for that lodgment, whichever is the later. • Taxpayers who do not have a regular pattern of home office use upon which a representative pattern may be based will need to keep records of the duration and purpose of each use of their home office during the year. Calculation methods

• Taxpayers claiming deductions for home office expenses such as electricity, gas and depreciation on office furniture may claim either a deduction for the actual expenses incurred or a deduction calculated at the rate of 52 cents per hour effective. Other expenses, such as telephone expenses and depreciation on computers or other equipment, will have to be calculated separately. • Based upon actual use or an established pattern of use, the ATO will accept that a taxpayer has incurred 52 cents per hour for home office expenses for heating, cooling, lighting and depreciation of furniture. This rate is based upon average energy costs and the value of common furniture items used in home offices. However, due to larger variations in cost of computers, telephone, faxes, etc, the taxpayer will still have to calculate depreciation on other items in their home office separately. • Taxpayers who choose to use the actual costs method need to keep appropriate records to be able to show the amounts of the expenses incurred and the extent to which they are incurred in deriving assessable income. Example Betty is an employee accountant working for a city-based firm that expects her to complete a specified amount of work each day. In order to achieve this, Betty chooses to take some of her work home at night so that she can spend more time with her family. Betty spends an average of two hours per night Monday to Friday working in her home office. Betty has two options for calculating her running expenses, both of which require her to keep a log to apportion between incomeproducing activities and private/domestic use, aside from depreciation on her computer equipment (which is common to both scenarios but separately calculated). Option 1 — Actual running expenses Betty had the following home office running expenses, including energy expenses which have been calculated using electricity authority hourly costs per appliance. The apportionment has been based on four weeks’ diary entries as follows:

Item

Calculation

Expense amount   ($)

Depreciation on desk

Value $350 over 10 years

35.00

Depreciation on chair

Value $320 over 10 years

32.00

Electricity for 60W ceiling light

5c/hr for 10 hr/w for 48 weeks

24.00

Electricity for computer

10c/hr for 10 hr/w for 48 weeks

48.00

Electricity for heating/cooling

20c/hr for 10 hr/w for 48 weeks

96.00

Total deductible amount

$235.00

Option 2 — Estimated running expenses Betty is able to use a simpler and quicker calculation for her running expenses:

Item

Running expenses

Calculation

52c/hr for 10 hr/w for 48 weeks

Expense amount   ($) 249.60

Temporary shortcut method of calculating home office running expenses For the period from 1 March 2020 until 30 September 2020, there is a separate shortcut method available for claiming additional running costs to take into account people working at home as a result of the COVID-19 pandemic (Practical Compliance Guideline PCG 2020/3). This method can only be used as an alternative to the other methods. The shortcut method enables taxpayers to claim 80 cents per hour for additional running expenses. Unlike the usual methods, there is no requirement for there to be a dedicated work area to claim the deduction, and the hours can be recorded by way of timesheet or diary notes.

The 80 cents per hour that can be claimed under the shortcut method is inclusive of all running expenses, and no additional running expense deductions (eg phone, internet and depreciation of equipment) can be claimed in conjunction with this method. However, it can be claimed by more than one person in the household.

¶12-068 Deductibility of work-related expenses when you have a home office A person who has a home office may be entitled to additional deductions for work-related expenses as follows: • The business-related portion of telephone expenses can be claimed as a deduction. If the person is required to be on call or to regularly phone the employer, a percentage of the cost of the calls and telephone rental is deductible. This is only available where the shortcut method is not claimed. • Travel between the home office and other places of work may be deductible. Travelling expenses are deductible where they are incurred in the course of the taxpayer’s work. There are no deductions for travelling between one place of work and another where one of the places of work is the taxpayer’s place of residence. On this basis, the following are situations in which deductions should be allowed for travel from the person’s home: – where the person’s employment is regarded as having commenced before, or at the time of, leaving home. The most common example is of a computer consultant who is on call 24 hours a day to provide technical assistance to their employer’s customers from home, either over the telephone or through a computer terminal installed there. If they are unable to answer the query over the phone and are required to travel to the employer’s place of work, the travel between home and work will be deductible. In such a case, the person effectively has two places of work, being home and the employer’s premises – where the person has to transport bulky equipment necessary for employment. It is considered that the expenditure is for the transport of the equipment rather than the person (which is what gives it the deductible flavour) – where the person’s employment is inherently of an itinerant nature, eg a school teacher who is required to teach at many different schools in any one week – where the person is required to break a normal journey to perform employment duties (other than incidental duties such as collecting newspapers, mail, etc) on the way from home to their usual place of employment (or vice versa). In such a case, the total journey from the employee’s home to the office should be accepted as business travel. • Any other items that are sufficiently related to the person’s income-earning activities should also be deductible. • As previously mentioned in the chapter, a taxpayer falling within the personal services income regime may not be entitled to some of the additional deductions mentioned above.

TAXES ON FOREIGN RESIDENTS ¶12-070 CGT withholding tax A non-final CGT withholding tax is imposed on the sale of taxable Australian real property, or an indirect Australian real property interest, by a foreign resident. The CGT withholding tax is imposed at a rate of 12.5% of the gross value of the property where the property has a value of $750,000 or more. Most importantly, while this withholding tax is intended to only apply to a sale of property by a foreign resident, every seller of a property with a value in excess of $750,000 is treated as a foreign resident unless the seller obtains an ATO “clearance certificate” proving they are a resident (¶12-072). Accordingly, unless the seller of real property with a value equal to or more than $750,000 is able to

provide the seller with a clearance certificate prior to settlement of the sale, the purchaser will be required to deduct withholding tax from the sale proceeds at the required rate and remit it to the ATO. Further, while the withholding tax is referred to as a CGT withholding tax the withholding applies even if the asset is held as trading stock or other revenue asset. The withholding tax is imposed on the value of the property. Provided the sale transaction has been negotiated on an arm’s length basis, the purchase price will be treated as the value. The imposition of the withholding tax for a sale of property can be summarised by the following flowchart.

¶12-071 When must tax be withheld, and claiming the credit The non-final withholding tax is required to be applied unless the market value of the property is less than $750,000, or the seller provides the purchaser with an ATO clearance certificate (¶12-072) prior to the purchaser becoming the owner of the property (ie usually on settlement). The withholding is required on or before the day the purchaser becomes the owner of the asset and must be paid to the ATO without delay. Where an amount is withheld, the purchaser is required to complete an online “Purchaser Payment Notification” form to provide details of the vendor, purchaser and the asset being acquired to the ATO. The penalty for failing to withhold is the amount that was required to be withheld and paid. In this manner a purchaser who fails to withhold and pays the full amount to the seller, will still be liable for the withholding in addition to the sale price. As a non-final withholding tax, a seller that has had withholding tax deducted still needs to lodge a tax return including the taxable capital gain or other taxable income from the sale. The seller is entitled to a credit for the tax withheld. Example Mike is a foreign resident that acquired a property on 15 March 2018 with a cost base of $1.7m. On 16 June 2020, Mike entered into an agreement for the sale of the property for Jessica for $2.2m with a settlement date of 28 July 2020. As a foreign resident, Mike is not entitled to obtain a clearance certificate and did not apply for a variation in withholding tax. On settlement, Jessica pays the purchase price by: • paying Mike $1,925,000 directly • withholding $275,000 from the purchase price which is paid to the ATO and providing Mike with a Purchaser Payment Notification.

Mike makes a capital gain on the sale of $500,000 (being $2.2m less $1.7m). As a foreign resident, Mike is not entitled to the CGT general discount. Mike has no other taxable Australian income during the year. When Mike lodges his 2020 tax return he is required to include the $500,000 capital gain. The tax payable is $206,550. Mike claims a credit for the $275,000 CGT withholding tax withheld and is entitled to a refund of $68,450 on assessment.

Variation of withholding Where the seller is not entitled to a clearance certificate (eg the seller is a foreign resident), but believes the prescribed withholding is inappropriate, the seller can apply to the ATO for a variation of the withholding tax rate. For example, a variation may be appropriate where the vendor will make a capital loss on the sale of the property. A variation can be applied for by the seller completing an online “Variation application for foreign residents and other parties” form and requesting a lesser withholding rate be determined by the ATO. In the majority of cases, variation will be provided by the ATO within 28 days where all the required information has been provided. The notice of variation needs to be provided to the purchaser before settlement to ensure the reduced withholding rate applies. Claiming the credit As noted above, where an amount is withheld, it is a non-final withholding tax. Accordingly, taxpayers will need to lodge a tax return for the relevant year of income to claim the withholding tax credit. Usually, the credit will be available for the year of income in which the CGT event occurs. However, in certain circumstances where, for example, the date of contract for the sale of land and the date of settlement (when the withholding obligation arises) straddles two different income years for the vendor there will be a mismatch between the CGT event and the availability of the withholding credit. The Commissioner has made a legislative determination to ensure that the withholding credit is available in the same income year as that in which the transaction giving rise to the withholding is recognised for tax purposes.

¶12-072 Clearance certificate The seller may apply to the ATO for a clearance certificate at any time they are considering the disposal of real property, including prior to the property being listed for sale. The clearance certificate will be valid for 12 months from issue and must be valid at the time the certificate is given to the purchaser prior to settlement to be effective. The ATO has an “automated” process for issuing a clearance certificate by the seller (or their agent) completing an online “clearance certificate application for Australian residents” form. The information on the application is automatically checked against information held by the ATO to assess if the vendor should be treated as an Australian tax resident for the purposes of the transaction and whether a certificate will be issued. In straightforward cases where the ATO has all the required information, the clearance certificate is expected to be provided within days of being submitted. However, where there are data irregularities or exceptions, some manual processing may be required and the clearance certificates will be provided within 14–28 days. Higher risk and unusual cases may also require greater manual intervention which could take longer.

¶12-075 Additional taxes on foreign resident owners In addition to the CGT withholding tax (¶12-070), there are a range of other taxes which may be imposed on foreign residents when acquiring or owning a home in Australia. These taxes are summarised below. Stamp duty surcharge A stamp duty surcharge applies to foreign purchasers of residential purchases in certain states. The rates as they apply as from 1 July 2020 (unless stated otherwise) are: • New South Wales — 8% • Victoria — 8% • Queensland — 7%

• South Australia — 7% • Tasmania — 8% for residential property and 1.5% for primary production land • Western Australia — 7%. In New South Wales, holders of retirement visas subclass 410 and 405 are exempt from foreign investor surcharge. Land tax absentee owner surcharge Land tax surcharge applies to a foreign person who owns residential real estate in certain states, unless otherwise exempted, as follows: • New South Wales — 2% of the full taxable value of NSW landholdings without any tax-free threshold. Holders of retirement visas subclass 410 and 405 are exempt from the surcharge. An exemption can be claimed by foreign persons who are permanent residents of Australia on the taxing date and who use and occupy the land as a principal place of residence for a continuous period of 200 days in the land tax year. • Victoria — 2% of the taxable value but only applies if the owner is absentee owner, being a person that is neither an Australian citizen or permanent resident, that does not ordinarily reside in Australia and was absent from Australia on the taxing day or six months or more in the previous year. Subject to limited exemptions, a vacant residential land tax of 1% will also apply to properties held in the inner and middle suburbs of Melbourne which are unoccupied for more than six months (see ¶12058). • Queensland — where a landowner is an absentee owner the owner will is liable to higher rates of land tax and a lower tax-free threshold of $349,999. Absentee owners are also subject to a land tax surcharge of 2% of the taxable value in excess of $349,000. • Australian Capital Territory — 0.75% applies to foreign owners of residential properties. An individual will be a foreign person where they are not Australian citizens that do not ordinarily live in Australia. A foreign person will also include trusts and companies that foreign persons hold substantial interests in. Annual agency fee for foreign-owned vacant residential properties Foreign owners of vacant residential property, or property that is not genuinely available on the rental market for at least six months per year, are charged an annual fee of at least $5,000. The annual fee will be equivalent to the relevant foreign investment application fee imposed on the property when it was acquired. Foreign owners of vacant land are not liable for a vacancy fee return until a dwelling has been constructed on the land. When multiple dwellings are constructed on the land, a vacancy fee applies to each new dwelling constructed. This levy is imposed persons that make a foreign investment application for residential property from 7.30 pm (AEST) on 9 May 2017.

GST IMPLICATIONS ¶12-080 GST and the family home The goods and services tax (GST) can affect several matters relating to the family home, including: • acquisition of the family home (¶12-081) • sale of the family home (¶12-082)

• renovations/repairs (¶12-083) • rent (¶12-084).

¶12-081 GST and acquisition of the family home Whether or not GST is payable upon the purchase of a home depends on whom the home is purchased from. If the residence is purchased from another individual or family, it will usually fall outside the GST net. If, however, the home is purchased from a developer in the ordinary course of the developer’s business, then it will be subject to GST where it is a new residential property. Where the home sold by the developer constitutes new residential property (ie a home that has not previously been a residential property), it will be subject to GST. GST will be charged under the ordinary rules unless the sale is eligible for, and the parties agree to apply, the margin scheme. The margin scheme will generally apply where the property was originally acquired by the developer prior to the GST implementation date of 1 July 2000, or was acquired by the developer after that time pursuant to a transaction under which no GST was paid. The margin scheme generally results in less GST being paid. Where the property was acquired prior to 1 July 2000, the GST is only imposed on the increase in value of the property since 30 June 2000. Where the property was acquired after 1 July 2000 in a non-GST transaction, the GST is imposed on the difference between the sale price and the acquisition price. With effect from 1 July 2018, purchasers of new residential properties or new subdivisions are required to remit the GST directly to the ATO as part of settlement, instead of to the seller. The rate of the withholding is generally 1/11th of the purchase price. However, where the margin scheme applies, the rate of the withholding is reduced to 7% of the purchase price. If the supply is made between associates for less than market value consideration the payment is required to be 10% of the GST exclusive market value of the property. The vendor needs to provide the purchaser with a notice in relation to the requirement to withhold. Where the home is used as a family home or a rental property, the purchaser will not be entitled to an input tax credit for the GST paid to the developer.

¶12-082 GST and sale of the family home The sale of an existing family residence will not usually be subject to GST because it is input taxed. This means that GST will not be payable on the sale price of the residence and the vendor will not be entitled to any GST credits in respect of GST paid for things such as renovations or repairs to the home during the period of ownership. However, the sale of the family home will give rise to the payment of GST on: • the fee or commission for the services provided by the real estate agent, conveyancer, solicitor, etc • expenses incurred in relation to the sale, such as advertising, search fees, etc. The GST included in these costs cannot usually be claimed as an input tax credit.

¶12-083 GST and renovations/repairs to the family home Most renovations or repairs undertaken to a home and carried out by tradespeople will have GST added to the costs involved. It will not usually be possible for the home owner to claim a credit in respect of the GST paid. However, it is expected that the sale price will reflect the amount of any work completed on the home, including the additional cost due to GST. This situation will be the same where the home is rented out.

¶12-084 GST and renting the family home Where a home is rented for residential purposes, no GST can be charged on the rent received. Any repairs, etc required to be made to the rental property will be treated as outlined at ¶12-083.

GOVERNMENT GRANTS AND ASSISTANCE ¶12-090 Concessions for the family home The government provides a range of assistance to individuals purchasing homes. The main assistance provided is a grant available for first home owners. However, there is other assistance available. In general, the benefits available are: • First Home Owner’s Grant (¶12-091) • additional concessions for first home owners (¶12-092) • other benefits for home owners (¶12-096) • First Home Loan Deposit Scheme (¶12-097) • first home super saver scheme (¶12-098).

¶12-091 First home owner’s grant A purchaser who qualifies as a first home owner may be eligible for the government’s First Home Owner’s Grant or equivalent schemes. The amount of the grant, the amount of the purchase price cap and the basis of eligibility depend upon the state or territory in which the home is purchased. The details of the First Home Owner’s Grant in each state and territory as from 1 July 2020 are summarised in the following table. State/Territory

Purchase cap

Amount

Qualification

New South Wales

$750,000 or $600,000

$10,000

Known as First Home Owner’s Grant (New Home) scheme is available for the purchase of a new property up to $600,000 or for builders who purchase land with a land and property package of up to $750,000.

Northern Territory

No cap

$10,000

The grant is available if buying or building a new home.

Queensland

$750,000

$15,000

Known as the First Home Owner’s Grant and is only available for buying or building new homes.

South Australia

$575,000

$15,000

Grant only applies for the purchase or construction of a new home.

No cap

$20,000

Grant only applies for the purchase or construction of a new home. Members of the Defence Force are exempted from the residence requirement.

Tasmania

Victoria

Western Australia

$750,000

$750,000   or    $1,000,000 

$10,000 or Grant only applies for the purchase or $20,000 construction of new homes. Higher grant applies if home is built in regional Victoria. $10,000

Grant only applies for the purchase of a new home. The higher purchase cap only available for homes purchased north of the 26th parallel.

Additional conditions may need to be satisfied in order to obtain the specific grant referred to that would need to be taken into account. The ACT does not have a First Home Owner’s Grant.

¶12-092 Additional benefits for first home owners In addition to the First Home Owner’s Grant and equivalent schemes detailed in ¶12-091 above, there are additional grants or benefits available for first home buyers in certain states and territories. Some of the additional benefits that may be available in the 2020/21 income year are as follows: • Australian Capital Territory — The Home Buyer Concession Scheme allows for first home buyers with a household income below $160,000 (with threshold increased by $3,330 per dependent child, up to five children) to pay no transfer duty, regardless of the property’s value or whether they are buying a new or established property. • New South Wales — Transfer duty is abolished for first home buyers of existing and new homes worth up to $650,000 and discounted for homes valued between $650,000 and $800,000 under the First Home Buyers Assistance Scheme. However, for the period 1 August 2020 to 31 July 2021, the exemption for first home buyers of new homes is increased to $800,000, with concessional rates applying up to $1m. Eligible purchasers buying a vacant block of residential land to build their home will pay no duty on vacant land valued up to $350,000, and will receive concessions for vacant land valued between $350,000 and $450,000. These thresholds are temporarily increased to $400,000 and $500,000 for the period of 1 August 2020 to 31 July 2021. • Queensland — Concessional rates of transfer duty apply for first home owners that acquire a residential property to be occupied as a principal residence for $550,000 or less, or vacant land on which a principal residence will be built that was acquired for $400,000 or less. • Northern Territory — There are a range of concessions for first home buyers being: (a) Household goods grant scheme which provides a grant of up to $2,000 for parties eligible for the First Home Owner’s Grant for new homes to purchase household goods. (b) Home renovation package which provides a $10,000 package for first home owners to renovate or improve the property up to 30 November 2020. (c) BuildBonus Grant which provides a grant of $20,000 to the first 600 applicants from 8 February 2019 buying or building a new home in the Northern Territory. • Tasmania — provides a 50% duty concession to first home buyers of established homes with a dutiable value not exceeding $400,000. • Victoria — A stamp duty exemption applies to eligible first home buyers acquiring a new or established property with a dutiable value of $600,000 or less. The exemption is available where the purchaser was eligible for the First Home Owner’s Grant or would have been eligible but for the new home requirement. A concessional rate will apply for dutiable value between $600,001 and $750,000. • Western Australia — Home Buyers Assistance Account grant of up to $2,000 for the incidental cost of homes purchased through a real estate agent for a $400,000 purchase price or less. In addition, if a purchaser is eligible for the First Home Owner’s Grant, a concessional rate of stamp duty applies for the purchases of homes up to $530,000 (with a full exemption for purchases up to $430,000) or vacant land up to $400,000 (with a full exemption for purchases up to $300,000). First home owners seeking to build or renovate should also consider eligibility for the HomeBuilder scheme (see ¶12-096).

¶12-096 Other benefits for home owners

Where the purchaser is a not a first home owner, there may be other benefits that are available in the relevant states and territory. The main benefits available are as follows. Australian Capital Territory • Mortgage relief loan scheme provides for interest-free loans up to $10,000 for five years for owners suffering mortgage stress. The loan can be applied against a combination of arrears (up to $5,000) and future mortgage payments. The loans are only available for properties of up to the median house price. New South Wales • Non-foreign buyers who are purchasing a home they plan to live in off-the-plan (regardless of whether they are first home buyers or not) are entitled to a 12-month delay in the payment of transfer duty, deferring payment from three to 15 months after settlement. Queensland • Concessional transfer duty applies for the first $350,000 of the dutiable value of a property acquired for the purpose of using as a principal residence within 12 months of acquisition. • Mortgage relief loan which provides short-term help to people who are having difficulties with their home loan repayments. The loan is up to $20,000, repayable over 10 years and interest-free with no application fees or ongoing charges. Repayments start 12 months after getting the loan. Northern Territory • Home Buyer Initiative makes it possible for middle- or low-income earners to buy new residential property or to build on vacant residential land. The properties are those specified to be within the scheme. • The Territory home owner discount provides a discount of up to $18,601 off stamp duty if a person is buying an established home, a new home or land to build a new home which will be the principal place of residence. • HomeBuild Access Loan provides special loans for certain low- and middle-income earners where a new home is to be purchased or built. The loans are available for new homes with a purchase limit of $475,000 for one to two bedrooms or $550,000 for three or more bedrooms. The alternative loans available are the following: (a) the HomeBuild Access Low Deposit Loan — provides a Territory Government loan of up to 17.5%, with an 80% loan provided through an approved financier, currently People’s Choice Credit Union. Applicants may also apply for the HomeBuild Access Off The Plan Deposit Loan which helps fund the deposit when entering an off-the-plan purchase contract. (b) the HomeBuild Access Subsidised Interest Rate Loan — reduces the home loan interest rate for the first five years of the loan term. Applicants are also eligible for a fee assistance loan that enables borrowing of up to $10,000 interest-free to help with costs associated with buying a home, such as conveyancing, white goods, deposit and stamp duty. • The Senior, Pensioner and Carer Concession available for eligible senior citizens, pensioners and carers who acquire a home or land on which to build a home by providing a concession of up to $10,000 off the stamp duty payable. Eligibility ceases if the dutiable value of the home or land exceeds $750,000 and $385,000 respectively. Tasmania • There is a 50% concession on stamp duty available to eligible pensioners that sell their existing home and downsize to a property with a dutiable value not exceeding $400,000 and that home has a lower dutiable value than the house sold.

Victoria • Concessional rates of transfer duty apply for purchases of property intended to be used as principal place of residence. • A one-off pensioner exemption/concession applies to the acquisition of a home to be used as a principal place of residence for a home valued up to $750,000. The full exemption applies up to $330,000 and the concession applies between $330,000 and $750,000. The exemption/concession can only apply once. • An off-the-plan duty concession applies to land and building purchases or refurbishments of existing building provided the property will be occupied as the main residence. The concession is relevant for determining the dutiable value for the principal place of resident exemption and the new first homebuyer duty phase in concessions. The dutiable value for these purposes is the purchase price less the construction costs incurred after the date of contract. • Eligible farmers aged below 35 may be eligible for a transfer duty exemption when buying their first single parcel of farmland less than $600,000. A concession is available for purchases between $600,000 and $750,000. Additional conditions are required to be satisfied for each of the concessions which would need to be considered. HomeBuilder As a result of COVID-19, the federal government is temporarily providing eligible owner-occupiers (including first home buyers) a grant of $25,000 to build a new home or substantially renovate an existing home. To be eligible, the relevant contract must be signed between 4 June 2020 and 31 December 2020 and the construction must start within three months of the contract date. To access HomeBuilder, the owner-occupier must meet all of the following eligibility criteria: • be an Australian citizen of at least 18 years of age • meet one of the following two annual income caps based on the 2018/19 tax return(s) or later: – $125,000 for an individual, or – $200,000 for a couple • the building contract is entered into between 4 June 2020 and 31 December 2020 to either: – build a new home as a principal place of residence, where the property value does not exceed $750,000, or – substantially renovate an existing home as a principal place of residence, where the renovation contract is between $150,000 and $750,000, and where the value of the existing property does not exceed $1.5m • construction must commence within three months of the contract date.

¶12-097 First home loan deposit scheme The federal government’s First Home Loan Deposit Scheme provides assistance to support first home buyers purchase a home sooner. It does this by providing a guarantee that will allow first home buyers to purchase a home with a deposit of as little as 5% without needing to pay for lenders mortgage insurance. The Scheme is not available for parties with 20% or more saved. The guarantee is not a cash payment or a deposit for the home loan. Eligible first home buyers are able to obtain an eligible loan to purchase an eligible property through a participating lender with up to 15% of the value of the property guaranteed.

The Scheme will support up to 10,000 guaranteed loans per financial year. The program is available for first home buyers with an annual income of up to $125,000, or couples with a joint annual income of up to $200,000, for the previous financial year. An applicant must intend to be an owner-occupier of the purchased property. The property to be purchased must be residential property. The property to be acquired must not exceed the following thresholds: Capital city and regional centres

Rest of state

New South Wales

$700,000

$450,000

Victoria

$600,000

$375,000

Queensland

$475,000

$400,000

Western Australia

$400,000

$300,000

South Australia

$400,000

$250,000

Tasmania

$400,000

$300,000

Australian Capital Territory

$500,000

—

Northern Territory

$375,000

—

State/Territory

¶12-098 First home super saver scheme The First Home Super Saver (FHSS) scheme aims to provide an incentive to enable first home buyers to build savings faster for a home deposit, by accessing the tax advantages of superannuation (¶4-222). Pursuant to the scheme, individuals are able to make voluntary contributions to their superannuation of up to $15,000 per year and $30,000 in total which may be later withdrawn for the purpose of applying as a deposit for their first home. Any contributions made into superannuation for these purposes must be made in accordance with an individual’s existing contribution caps. The contributions are classified as concessional contributions. Based on the concessional contribution cap of $25,000, the maximum amount of contributions that can be made in a year is the higher of $15,000 and $25,000 less contributions made in accordance with the superannuation guarantee contribution scheme. The individual is then able to withdraw these contributions and their associated deemed earnings to apply to the deposit for the acquisition of their first home. A withdrawal from the superannuation fund will be taxed at an individual’s marginal tax rate, less a 30% tax offset. The ATO is required to withhold an amount from the payment under the scheme. Under the FHSS, both members of a couple can take advantage of this measure to buy their first home together.

ACQUISITION/CONSTRUCTION OF FAMILY HOME ¶12-100 Structuring the acquisition of the family home Normally, a home is purchased in the name of one or more of the individuals who are to live in it. However, in some cases, the home might be purchased by a company or trust to protect it from the claims of creditors or potential litigants. The tax implications of doing this need to be clearly understood before taking such a course of action. For example, some people purchase a home in a company or trust so that it may be negatively geared. The company charges the family rent for the home and claims deductions in respect of interest payments. This arrangement will be subject to CGT on its sale as the main residence exemption will not apply, the CGT discount will not be available if owned by a company and the use of the home may potentially give

rise to fringe benefits tax (FBT) or Div 7A deemed dividend implications. ACQUISITION BY AN INDIVIDUAL Advantages of owning family home in individual’s name

Disadvantages of owning family home in individual’s name

• Simplicity of transactions • Stamp duty and land tax exemptions may be available • The CGT main residence exemption may be available • The 50% CGT discount is available to resident individuals • Possible access to the First Home Owner’s Grant and associated benefits

• If property later becomes income-producing, any capital gain on disposal may be taxed at the individual’s marginal rate — subject to the CGT general discount of up to 50% where available Notes: (1) this may be an advantage if the property is negatively geared as deductions against rental income can be claimed (2) CGT will not be payable if the temporary absence rule allows for the full main residence exemption (¶12-640)

ACQUISITION BY A TRUST Advantages of owning family home in trust name

Disadvantages of owning family home in trust name

• If a discretionary trust is used and the property becomes income-producing, income can be distributed to beneficiaries with the lowest marginal tax rates • If a discretionary trust is used, any capital gain made when the property is sold can be distributed to beneficiaries with the lowest marginal tax rates. The CGT discount of up to 50% is then available to individual beneficiaries • The family home can be negatively geared if the trust/unitholders borrow in relation to the acquisition of the property and the trust charges the family a commercial rent

• The CGT main residence exemption is not available • Stamp duty exemptions may not be available • A liability for land tax may arise • Losses from negative gearing are trapped in the trust • FBT liability if provided in respect of employment at less than market value rent • ATO may view the transactions as part of a tax scheme • Cannot access the concessions for first home buyers

Caution The ATO issued Taxation Ruling TR 2002/18 in relation to homes acquired under a particular home loan unit trust scheme. The features of the home loan unit trust scheme under attack by the ATO are as follows: (1) the taxpayer and/or spouse establish a unit trust with a company as trustee. The taxpayer and/or spouse initially acquire a small number of units in the trust. The taxpayer and/or spouse are the directors of the trustee company (2) the taxpayer borrows an amount of money that approximates the value of a yet to be acquired residential property and uses the borrowing to acquire more units in the trust. The trust gives a guarantee to the lender over the taxpayer’s borrowing (3) the unit trust then purchases a residence that is leased to the taxpayer and/or spouse at market rental with annual rent reviews. The trust grants a mortgage over the residence to the lender as security for the taxpayer’s borrowing. In some cases, the term of the lease is for 50 years (4) subsequently, the taxpayer and/or spouse pay rent to the trust under the lease. The trust pays the expenses on the property such as water and council rates and insurance. The trust claims deductions for those expenses and also claims any depreciation or other capital allowance deductions that apply in respect of investment properties (5) the trust’s taxable income is distributed to the unitholders. The taxpayer, as the major unitholder, receives most of this distribution and it is included in their tax return as assessable income (6) the taxpayer claims deductions against that income for the interest that is paid on the borrowing used to acquire the units in the trust. This results in an overall loss from the arrangement to the taxpayer that is offset against other income. The ATO believes this scheme represents an attempt by taxpayers to access tax deductions generally only available in respect of

investment properties, ie seeking deductions for essentially private expenditure. The ATO will attempt to attack these arrangements either by arguing that the interest expense is not deductible or that the antiavoidance provisions apply. Therefore, there are significant risks involved in using this strategy. ACQUISITION BY A COMPANY

Advantages of owning family home in company name

Disadvantages of owing family home in company name

• If the property subsequently becomes income-producing, any assessable income relating to that income-producing use will be taxed at the relevant corporate tax rate • The family home can be negatively geared if the company/shareholders borrow in relation to the acquisition of the home and the company charges the family a commercial rent

• The CGT main residence exemption is not available • Stamp duty exemptions may not be available • A liability for land tax may arise • Losses from negative gearing are trapped in the company • The benefits of indexation are lost on distribution • No CGT discount is available to companies • Division 7A deemed dividends will arise where rent is charged at less than market value • Cannot access the concessions for first home buyers

A company is not generally recommended as a vehicle for the purchase of real estate.

¶12-110 Financing the acquisition/construction of a home Interest on a loan used to finance the acquisition or construction of a home will generally not be deductible unless the home also serves as a place of business. A number of home loan products are available for use by taxpayers. However, the ATO’s attitude in relation to such products needs to be carefully considered before entering such a product. Offset accounts It is quite common for financial institutions to offer “offset” arrangements. The purpose of these offset arrangements is to enable a home owner to reduce an otherwise non-deductible interest outgoing — the home loan interest. It also has the effect of eliminating the tax that would otherwise arise on the interest earned on the funds deposited with the bank. Offset arrangements may operate either on a single account or dual account basis. Under a single account offset arrangement, a person can deposit funds into the home loan account with home loan interest being calculated on the reduced balance outstanding. A dual account offset arrangement differs only in that the balance in any linked deposit or savings account is “offset” against the amount outstanding on the home loan for the purpose of calculating the interest on the home loan. Generally, the ATO accepts that offset arrangements are effective in achieving this outcome provided: • in respect of single account arrangements — there is no entitlement to interest when the account is in credit • in respect of dual account arrangements — there is no entitlement to interest in respect of the balance in any deposit or savings account. Split loans Financial institutions also offer “linked” or “split” loan facilities which involve two or more loans or subaccounts. Traditionally, these facilities have been used to purchase a family home by using one account to purchase the family home and the other account for a business or income-producing purpose. Repayments on the facility are allocated first to the private account with the unpaid interest arising on the business account. The intended purpose was to maximise the potential interest deduction by creating interest on interest.

However, the High Court in FC of T v Hart & Anor 2004 ATC 4599 ruled that such an arrangement triggered the general anti-avoidance provisions and that the additional or capitalised interest on the business account was not deductible. These arrangements are addressed in Taxation Ruling TR 98/22 which provides that a taxpayer using such an arrangement is only entitled to a tax deduction for the amount of interest that would have been payable on the income-producing loan if the interest had not been capitalised. Accordingly, such arrangements are not considered to be tax effective. In Taxation Determination TD 2012/1, the Commissioner expresses the view that the general antiavoidance provisions in the Income Tax Assessment Act 1936 (ITAA36) Pt IVA could apply to “an investment loan interest payment arrangement” pursuant to which repayments are primarily applied against the loan for the acquisition of a personal residence in preference to the loan for the investment property. This is despite notwithstanding that the taxpayer has the purpose of “paying their home loan off sooner” or “owning their own home sooner”. Interest deduction generators In Taxpayer Alert TA 2009/20, the ATO has questioned the use of arrangements pursuant to which a taxpayer refinances an existing home loan for the purpose of investing in shares in a company controlled by a promoter of the arrangement. The company does not usually carry on a business or produce assessable income. The arrangement is intended to allow a deduction for the interest payable on the loan as it has been used to purchase shares in the company. However, the ATO claims that the interest is not deductible either because the arrangement is a sham or the loan funds are not used for an incomeproducing purpose and therefore the interest is not deductible under the general provisions.

¶12-120 Main residence exemption for homes that are constructed A taxpayer may be entitled to a main residence exemption (¶12-053) in respect of vacant land where a dwelling that becomes the taxpayer’s main residence is built upon the land. The main residence exemption will be available for up to four years, or such longer time as the Commissioner allows in his discretion, provided: • the taxpayer moves into the dwelling as soon as practicable, and • the dwelling remains the taxpayer’s main residence for at least three months after moving in. If the land is sold when it is still vacant, the main residence exemption will not be available.

FAMILY BREAKDOWN AND THE FAMILY HOME ¶12-200 Consequences of property settlement The domestic dwelling will generally be one of the most substantial assets of a couple undergoing a separation or divorce. It is common in this situation for the family home and other property to be transferred between the parties as part of a property settlement. If the ordinary CGT rules applied, the transfer would have the following consequences for CGT purposes: • if the asset is pre-CGT, the disposal has no CGT consequences for the transferor. However, the transferred asset is deemed to be a post-CGT asset acquired by the transferee at market value and may be subject to CGT on its subsequent disposal • if the asset is post-CGT, the transferor is treated as having disposed of it at market value and a capital gain or loss will be calculated accordingly. The transferee is taken to have acquired it for market value and it may be subject to CGT on its subsequent disposal. These effects may be deferred by means of the CGT marriage breakdown rollover (¶12-210), but keep in mind that the rollover may not be beneficial in all situations (¶12-215). Where a dwelling nominated as a main residence temporarily ceases to be a main residence, a person

may choose to have the CGT main residence exemption continue to apply to that residence. Such a situation could arise where, for example, the wife moves out of the family home. At the time she leaves, the family dwelling is no longer her physical main residence. However, she may elect that it continues to be her main residence for an additional period provided no other property is claimed as her main residence during that time. There is a six-year limit on this period if the residence is income-producing during the absence or an unlimited period if the property is not income-producing during the absence (¶12-640).

Note Once parties separate, they are each entitled to full separate main residence exemptions rather than the maximum 50% exemption while together (¶12-680).

¶12-210 Marriage breakdown CGT rollover relief CGT rollover relief applies where an asset is transferred between spouses on the breakdown of marriage or relationship where certain conditions are met. The conditions which must be met are: • there is a transfer • the disposal of the asset is to a spouse or former spouse only • the disposal is pursuant to any of the following: – a court order under the Family Law Act 1975, a state, territory or foreign law relating to breakdown of relationships between spouses – a court-approved maintenance agreement or a similar agreement under a foreign law – an arbitral award under the Family Law Act 1975 or a corresponding arbitral award under a corresponding state, territory or foreign law – a binding financial agreement under Pt VIIIA of the Family Law Act 1975 or a corresponding written agreement that is binding because of a corresponding foreign law – a written agreement that is binding because of a state, territory or foreign law relating to breakdowns of relationships between spouses where the agreement cannot be overridden by a court order except to avoid injustice – a Pt VIIIAB financial agreement under the Family Law Act 1975 or corresponding written agreement that is binding because of a corresponding foreign law. In relation to the last three grounds, the rollover only applies where the spouses are separated, there is no reasonable likelihood of cohabitation being resumed, and the transfer occurred because of reasons directly connected with the breakdown of the marriage/relationship. For the purpose of satisfying the conditions, the definition of a “spouse of an individual” includes another individual (whether of same or different sex) who lives with the first individual on a genuine domestic basis. This ensures that the parties of the breakdown of a marriage or other genuine domestic relationship (including same-sex relationships) have equal access to rollover relief. Where these conditions are satisfied, the CGT rollover relief applies automatically. This means two things: first, it is not necessary to make an election for the rollover relief to apply; and second, the parties have no choice as to whether it applies. A marriage breakdown rollover also happens where a company or trustee of a trust disposes of, or

creates, an asset for the spouse of the individual taxpayer as a result of a marriage breakdown and similar conditions are satisfied. The effect of the rollover relief is that: • no CGT liability arises to the transferring spouse as a result of the transfer • where the rollover asset was originally acquired pre-CGT, the transferee spouse is deemed to also have acquired the asset pre-CGT and therefore no CGT liability will arise when the transferee spouse subsequently disposes of the asset • where the rollover asset was acquired post-CGT, the transferee spouse is deemed to have paid as consideration for the acquisition of the asset, whichever of the following is appropriate: – an amount equal to the cost base (indexed if appropriate) to the transferor spouse at the time of transfer. This cost base includes any amounts paid by the transferor spouse which are eligible to be included in the cost base of an asset, such as, for example, conveyancing fees. The benefit of these payments by the transferor spouse is passed on to the transferee spouse and will assist to reduce any capital gain made on subsequent disposal of the asset. Conversely, the transferee spouse will be subsequently liable for any inherent capital gains in the asset to the date of transfer as well as those arising after that date – an amount equal to the reduced cost base to the transferor spouse at the time of transfer. The consequences of rollover relief effectively mean that the transferee spouse receives the asset with all the CGT attributes the asset had in the hands of the transferor spouse. The gain or loss for CGT purposes will therefore be deferred until the transferee spouse disposes of the asset. When a dwelling is transferred between spouses as a result of a marriage or relationship breakdown and CGT rollover relief is available, the CGT main residence exemption rules take into account the way in which both spouses used the dwelling during their ownership. Example Delia was the sole owner of a dwelling that she used entirely as a rental property for five years before transferring it to Damon as a result of a marriage breakdown. CGT rollover relief is available. Damon uses the dwelling as a main residence for five years before selling it. Damon is eligible for a 50% main residence exemption based upon how both Delia and Damon used the dwelling. Where the dwelling was used as a main residence and then, subsequent to the marriage breakdown, was used as a rental property, the special rule explained at (¶12-600) applies.

Example Nathan was the 100% owner of a dwelling that he acquired post-CGT for $100,000 and used it as a main residence for three years. It was valued at $160,000 at this time and he decided to use it as a rental property. The dwelling was later transferred to his exspouse Natalie, as a result of a marriage breakdown. CGT rollover relief was available. Natalie is taken to have acquired the ownership interest in the dwelling at the date it first became a rental property for $160,000.

¶12-215 Where CGT rollover may not be appropriate In the case of a pre-CGT asset, a rollover will have the beneficial result that the asset remains CGTexempt in the transferee’s hands, notwithstanding that it has been transferred post-CGT. In the case of a post-CGT asset, a rollover will effectively defer CGT liability on any capital gain which would otherwise arise until the asset is ultimately disposed of by the transferee. However, a rollover of a post-CGT asset may sometimes not be desirable for one or other of the parties, depending on factors such as: (i) whether the disposal of the asset is liable to give rise to a capital gain or a capital loss; (ii) the existing or expected tax position of each party apart from the transfer; and (iii) the expected future use or performance of the asset. In considering this matter, the interests of the transferor and the transferee may not always coincide.

Rollover is automatic if the preconditions for its operation are satisfied. Accordingly, if it is wished to avoid a rollover, one or more of those preconditions must not be met. For example: • instead of transferring the asset to the spouse or former spouse, the asset may be sold to a third party with the proceeds being split in the agreed manner • the asset may be transferred independently of a court order or court-ordered agreement, or pursuant to an order registered under the Family Law Act s 86 (as distinct from s 87 of the Act). In accordance with the legislation, a transfer of an asset to a related party of a spouse, such as to a trust, company or child, would not appear to satisfy the conditions for the rollover. The Full Federal Court held in Ellison & Anor v Sandini Pty Ltd & Ors; FC of T v Sandini Pty Ltd & Ors 2018 ATC ¶20-651 that rollover relief was not available on the transfer of an asset from a corporate trustee controlled by the husband to a corporate trustee controlled by the wife as a result of the marriage breakdown, reversing the earlier Federal Court decision. The High Court refused the taxpayer’s application for special leave to appeal against the decision of the Full Court decision.

RENTING OUT THE HOME ¶12-300 Renting out the whole or part of the home A home owner may decide to rent out the home because of a job transfer to another state/territory or country, or to rent out a spare room(s) to a lodger as a way of getting some extra income. Renting out the whole or part of the home has the following consequences for the owner: • any rent received will be assessable income • a deduction can be claimed for the GST inclusive amount of expenses such as interest, property rates and taxes and home insurance. The deduction should be apportioned on a floor area basis if only part of the property is rented out. Where more than one person owns the home, all income and expenses are generally apportioned between the owners in accordance with their legal title to the home • depreciation can be claimed on furniture, curtains, carpets and other items of plant in the home or the section of the home that is rented out. However, the depreciation deduction for furniture and fitting acquired from 9 May 2017 is limited to outlays actually incurred by the taxpayer (as opposed to amounts inherited from previous owner) • the cost of heating, cooling and lighting is deductible to the extent the cost relates to the use of the facilities by the tenant and is not reimbursed by the tenant. For the method of apportioning the relevant expenses between the home owner’s private use and those of the tenant, see ¶12-066 • where a home is negatively geared, a taxpayer may be eligible to apply for variations to their Pay As You Go tax instalments (¶11-270) • the benefit of the CGT main residence exemption may be reduced (¶12-580) • pension entitlements may be affected (¶12-700). Travel expenses related to inspecting, maintaining or collecting rent for a residential property are no longer deductible.

¶12-350 Taxation implications of Airbnb In recent years, the sharing economy has become very successful. One of the great successes has been Airbnb which allows home owners to rent rooms or the whole of their home to other parties for short to medium periods of time in exchange for a fee. The use of a person’s home in this manner will give rise to

taxation issues. The taxation consequences will depend upon whether the whole home is rented for a period of time or only parts of the property (eg one or two rooms) while the remainder of the house is still used as the owner’s main residence. The relevant taxation issues are summarised below. Income tax The rent received from the rental of the home, or a part of the home, will be assessable income to the owner. A tax deduction will be available for the expenses to the extent that they are incurred in deriving the rental income. For example, where the whole of the property is rented out a tax deduction would usually be available for the following expenses incurred during the period for the rental: (a) fees and commissions paid to Airbnb (b) advertising costs (c) food provided to guests (d) interest incurred on the loan to acquire or improve the property (e) repairs, cleaning and other maintenance (f) land tax (g) depreciation on the furniture (h) capital works deduction in relation to the property (i) council rates (j) insurance (k) utilities (l) internet. Where only one or two rooms are rented on Airbnb while the balance of the home is used as the owner’s main residence, the tax deduction will be limited to the expenses incurred in relation to the portion of the house rented, or available for rental. This will require apportioning the expenses into the following categories: (i) expenses incurred that solely relate to the portion of the property rented. For example, this would include items (a)–(c), repairs to rented rooms and depreciation on furniture used solely in those rooms. These expenses would be deductible in full. (ii) expenses incurred that relate to the entire property that need to be apportioned between private and rental purposes. Most of the other listed expenses will fall within this category. These expenses will need to be apportioned on a reasonable basis based on the relative use by the owner and that by renters. Depending on the expenses this can relate to floor area between areas used solely for private and solely by renters. Shared areas such as television rooms and bathrooms can be apportioned based on access. A deduction will only be available to the extent that it relates to the rental use. (iii) expenses which relate solely to the portions of the home used by owner and family. No deduction will be available for expenses incurred in relation to these areas. The ATO have provided some guidance on the Commissioner’s approach to taxation aspects of participating in the sharing economy.

Capital gains tax Where considering whether the property is to be used for rental on Airbnb the CGT implications would need to be considered. This is particularly important where the full main residence exemption would have otherwise have been available except for rental. Where the whole of the property is being rented out on Airbnb the full main residence exemption will continue to be available provided the: • period of the rental since ceasing to be the owner’s main residence did not exceed six continuous years before sale or recommencing residency • owner did not have any other property as a main residence, and • sale did not occur while the owner was a foreign resident for tax purposes (if proposals to exclude foreign residents from being eligible for main residence exemption passes into law). Where only part of the home is rented out, the full main residence exemption will no longer be available. The owner will only potentially be entitled to a partial main residence exemption. The capital gain will need to be apportioned on a reasonable basis based on the period of ownership used for rental purposes and the portion of the property used for income-producing purposes. Further details on apportionment are included from ¶12-580. GST As the home is being used for residential purposes, there will be no GST payable in relation to the rental of the property. Residential rent is input taxed. Therefore, GST on expenses incurred in relation to the property will not be able to be claimed back.

DISPOSAL ¶12-500 Consequences arising from disposal of family home The disposal of a family home may trigger tax consequences. The tax consequences depend on: • the nature and use of the family home • the owner of the family home • the taxpayer’s intentions in relation to the family home when it was acquired • the tax residency status of the taxpayer at the time of sale. The following flowchart provides a quick overview of the situation.

Was the home acquired with the intention of selling it at a profit? |

NO

YES

▾

▾

At the time of the sale is the person a foreign resident or temporary resident for tax purposes?

The sale of the home will give rise to assessable income under the income tax provisions (¶12-510).

NO

YES

▾

▾

Was the home used solely as the person’s main residence during the period it was owned by the person?

The sale of the home will generally not be eligible for the main residence exemption (¶12-645).

NO

YES

▾

▾

A partial or, in limited circumstances, a full exemption from CGT will be available (¶12580). See: • home used for income-producing purposes (¶12-056)

Subject to the home being a “dwelling” and owned by individuals, a full exemption from CGT should be available (¶12-053).

• renting out part of the home (¶12-300) • absences from the home (¶12-640) • where the home became a rental property (¶12-580, ¶12-640).

The CGT withholding tax implications as detailed in ¶12-070 need to be considered on a sale of the home. An individual may in some circumstances use proceeds from the sale of the main residence to make downsizer contributions to their superannuation: see ¶12-710. Where the home was acquired as a beneficiary in a deceased estate, the consequences are outlined at ¶12-800.

¶12-510 Home acquired with intention of selling at a profit Where a person acquires a home with the intention of selling it at a profit (ie as part of a profit-making scheme), a liability to income tax may arise when the property is sold. This will be the case even if the person and the person’s family live in the property as their main residence between the time it is acquired and the time it is sold. The following flowchart shows the tax consequences where a home was originally acquired with the intention of selling it at a profit.

Was the home acquired before 19 September

1985? |

YES

NO

▾

▾

The “profit” from the sale of the home will be assessable as ordinary income. CGT consequences may also arise on improvements made after 19 September 1985.

The “profit” made on the sale of the home will be assessable as ordinary income. The profit will also be assessable where it arises from the carrying out of any profit-making undertaking or scheme in relation to the home.

“Profit” refers to the net proceeds arising from the sale of the home. All expenses, such as interest on the home mortgage, associated with the scheme for the sale of the home should be deducted when making this net profit calculation. Example John Richardson, a builder, constructs a “spec” home in which he and his family live while another “spec” home is being built. As the “spec” home would originally have been constructed with the intention of selling it at a profit, the net profit on the sale of the home will be assessable to John under the income tax provisions, even though the sale of the home is exempt from CGT.

The CGT withholding tax implications as detailed in ¶12-070 need to be considered on a sale of the property.

¶12-580 Main residence exemption Generally speaking, the sale of the family home by a tax resident will be completely exempt from CGT (¶12-053). However, financial planners should be aware that in a number of circumstances only a partial exemption applies. Foreign residents for tax purposes are not generally eligible for the main residence exemption for sales after 9 May 2017, subject to grandfathering provisions that were available to 30 June 2020 (¶12-645). Partial CGT exemption In the following situations, a partial, rather than a full, main residence exemption is available: • the dwelling was used partly for income-producing purposes, eg part of the home was rented out or used as a place of business (¶12-056) • the dwelling was the main residence during only part of the time it was owned. The following flowchart highlights the consequences where a dwelling was a main residence for only part of the period it was owned by a person.

Did the person establish the dwelling as a main residence as soon as practicable after it was acquired? |

YES

NO

▾

▾

• The person is taken to have a market value cost base at the time it is first used to produce assessable income (¶12-600)

• A partial exemption from CGT will arise calculated on a proportionate basis (¶12-590).

• The person may be eligible to choose to apply the special rules for absences (¶12-640) • A partial exemption from CGT may arise calculated on a proportionate basis (¶12-590).

Refer to ¶1-325 to determine the types and amounts of deductions available to a taxpayer when a family home is converted into a rental property.

¶12-590 Dwelling not originally established as main residence Where a dwelling was not the main residence throughout the entire period it was owned by the person, any capital gain or loss realised when the dwelling is sold is calculated using the formula: capital gain or capital loss amount ×

 non-main residence days   days in ownership period 

where: • “capital gain or capital loss amount” is the capital gain or capital loss that would have been made when the dwelling was sold if no main residence exemption was available • “non-main residence days” is the number of days in the ownership period when the dwelling was not the main residence. Example Aileen, a tax resident, bought a house on 1 July 2012 as a rental property. The house was rented from 1 July 2012 to 30 June 2015. Aileen moved into the house on 1 July 2015 and established it as a main residence and lived there until its sale. The house was sold on 1 July 2020. If no main residence exemption was available, a capital gain of $60,000 would be realised when the house was sold. Instead, Aileen will be assessed for CGT as follows:

$60,000 ×

1,095 = $22,477*  2,923 

* Reduced to $11,238.50 after applying the 50% CGT discount as Aileen has always been a resident of Australia during the period of ownership.

Tip If the person established the dwelling as a main residence prior to renting it out, a full main residence exemption may still have been available pursuant to the temporary absence provision (¶12-640).

¶12-600 Dwelling originally used as main residence

Where a dwelling was used as a person’s main residence as soon as practicable after it was acquired and later used for the purpose of producing assessable income, the tax consequences are: • where the dwelling was first used to produce assessable income on or before 7.30 pm 20 August 1996 — the partial main residence exemption will be available as outlined above at ¶12-590 unless the taxpayer avails themselves of the temporary absence rule for the full exemption explained at ¶12640 • where the dwelling was first used to produce assessable income after 7.30 pm 20 August 1996 — the person is treated as having acquired the dwelling immediately before it first became incomeproducing for its market value at that time. The temporary absence rule detailed at ¶12-640 is still available to the taxpayer.

¶12-620 Delay in moving into a dwelling The main residence exemption may continue to be available to a person even where there is some delay in establishing the dwelling as a main residence. The exemption extends back to the date of purchase provided the person moved into the dwelling at the first time it was practicable to do so. The extended exemption covers situations where there is a delay in moving in due to illness or some other reasonable cause. The exemption does not extend to a case where a person is unable to move into the dwelling because it is being rented out or because the person was relocated for work purposes. In such a case, only a partial main residence exemption will be available (¶12-590).

¶12-630 Changing main residences Where an individual moves into a new main residence before selling the previous one, an exemption may be claimed for both dwellings as main residences for up to six months. This allows the person time to sell their previous home. This six-month overlap of exemption on two homes may also be used in conjunction with the special rule outlined in ¶12-640 and in situations where the taxpayer builds, repairs or renovates a dwelling.

¶12-640 Absences from main residence Even though a person has moved out of the main residence, they can choose to have that dwelling still treated as their main residence for CGT purposes for: • a maximum period of six years where the dwelling is used to produce income, eg it is rented out • an indefinite period where the dwelling is not used for income-producing purposes. During the period that this exemption applies, no other property can be treated as the person’s main residence for CGT purposes (unless the changing main residences provision applies (¶12-630)). This choice is only available in respect of a dwelling that has been the main residence of the taxpayer. Each time a person moves back into the home and establishes it as a main residence they become entitled to restart the six years of income-producing use and still maintain a full exemption. See also ¶12-590 and ¶12-600 for discussion of how the capital gain (or loss) is calculated. Example Tamara acquired a house. The house was her main residence for three years before she was transferred interstate. She rented out the house for five years and then left it vacant for three years before selling it. If Tamara chooses to treat the house as continuing to be her main residence while she is absent, a full CGT main residence exemption will be available when the house is sold.

Tip If a taxpayer lives in a home that was acquired pre-CGT, it will not be subject to CGT when it is sold. If the taxpayer buys a second home and uses it as their main residence before subsequently renting it out, the second home can be exempt from CGT for up to six years. If the taxpayer later reestablishes the second home as their main residence, the CGT exemption will apply for another six years. It is suggested that professional advice be obtained before implementing such a strategy as establishing whether a property is being used as a main residence can be problematic and the ATO may question the primary purpose behind such an arrangement.

Refer to ¶1-325 to determine the types and amounts of deductions available to a taxpayer when a person’s dwelling is used as a rental property.

¶12-645 Main residence exemption exclusion for foreign residents The main residence exemption is not available for a sale of a property by a foreign resident for tax purposes with effect from 7.30 pm (AEST) on 9 May 2017 unless the foreign resident has been a foreign resident for six years or less and satisfies the life events test. The life events test will be satisfied by a taxpayer where one of the following applies: • the taxpayer or taxpayer’s spouse or child under 18 years has had a terminal medical condition during that period of foreign residency • the death of either the taxpayer’s spouse or child under 18 years at the time of death during that period of foreign residency • the CGT event happens because of the taxpayer’s divorce or separation. Where the life events test is not satisfied, a foreign resident cannot apply any main residence exemption. There is no apportionment for the period in which person was a resident for tax purposes during the ownership period. However, if the taxpayer recommences their residency prior to the sale of the property, the main residence exemption is potentially available without the need to apportion for the period of foreign residency. Note for CGT events that occurred prior to 30 June 2020, a transitional rule applied to allow a foreign resident to apply the main residence exemption for a CGT event happening to a property that was held as at 9 May 2017.

¶12-650 Destruction of dwelling and sale of land A person can continue to use the CGT main residence exemption for the disposal of vacant land where the dwelling on it was accidentally destroyed, eg by a bushfire.

¶12-670 Adjacent land sold separately An exemption from CGT will not generally be available in respect of adjacent land, a garage, storeroom or other structure which is sold separately from the main residence.

Tip This rule will have particular impact on home owners in suburban areas who wish to subdivide their house block. If the subdivided part is sold separately, it will be subject to CGT. If both the house block and the subdivided part are sold as one transaction, the main residence CGT exemption is

potentially available.

The main residence exemption applies to a disposal of adjacent land to the main residence where the disposal is made pursuant to a compulsory acquisition or other involuntary events.

¶12-680 Spouse or child chooses a different main residence As a general rule, spouses (de facto and legally married) are together entitled to a CGT exemption in respect of only one dwelling at a time. Where a person and spouse (or a dependent child) each has a different main residence, the main residence will be the dwelling nominated by them. Where the parties nominate different dwellings, the exemption is apportioned over the two dwellings. The maximum exemption available to a person in respect of any one dwelling is limited to the lesser of their interest in the dwelling or one-half. A person may nominate a dwelling as a main residence even though the person has no interest in it. For example, a person may nominate a dwelling which is 100% owned by a spouse as the person’s main residence. The right to occupy is a sufficient interest in the dwelling for such a nomination to be made. For a dwelling to be nominated it must be the main residence of either the person or their spouse. Example Paul and Sarah purchased their home in Adelaide when they first married in 1990. In 2002, they bought a house in the Barossa Valley where they spend their holidays. Based on these facts, it will not be possible for Paul and Sarah to nominate the post-CGT Barossa Valley home as their main residence. This house is not the main residence of either Paul or Sarah.

¶12-700 Retirement and the family home A person’s home plays an important role in their wellbeing and retirees are no exception to this rule. Retirement brings with it a number of situations where the family home needs to be carefully considered. As well as the lifestyle and emotional issues that need to be resolved in such situations, other matters that need to be considered include: • treatment of the family home for the purposes of social security (¶6-560) • the aged care rules, including accommodation bonds and nursing home fees (Chapter 17) • the role of the home in an overall retirement plan (¶15-010; ¶12-010) • whether the family home could be used to provide income. See section on reverse mortgages below. Reverse mortgages Reverse mortgages are suited to retirees who are “asset-rich” and “income-poor”, that is, people who have the majority of their wealth tied up in the family home and need extra retirement income to improve their lifestyle. These retirees are unlikely to be able to take out an ordinary loan to meet their additional income requirements. A reverse mortgage (also known as “reverse equity products”, “home equity loans” or “equity release products”) allows a borrower to access the equity in the retirees’ home as a lump sum amount to provide additional income. However, repayments on the loan are not usually required until the borrower passes away or sells the home. When the loan ends and the home is sold, the retiree or the estate is required to repay what’s owing out of the sale proceeds. The effect of compounding interest and fees means the loan value rapidly increases over time with a corresponding decrease in the borrower’s equity. The amount that can be borrowed against the family home varies between product providers and is generally restricted to a maximum of 40% of the property value. Interest rates are also higher than

standard variable mortgage rates. The advantages of reverse mortgages are that: • they provide additional income in retirement • retirees can continue to live in the family home, with associated benefits such as remaining in the same area close to family and friends, and • the repayment of the loan is deferred. The disadvantages of reverse mortgages are that: • compounding interest will see the loan rapidly increase over time (see the example below) • it has establishment fees and ongoing maintenance fees • there will be a lower level of assets to leave to the borrower’s estate, and • the amount of loan could potentially exceed the value of the home. (However, note that many loans may include a “no negative equity guarantee”, which means that, provided the terms and conditions of the loan have been met, the lender cannot seek additional repayment from the borrower personally, or from their estate, if the value of the property is insufficient to fully repay the loan.) Example George borrowed $100,000 at an interest rate of 7.5% pa under a reverse mortgage scheme. The amounts that will have to be repaid by the estate when the house is sold are shown below:

Time until house is sold and loan is repaid

The amount owed at the time the house is sold

5 years

$143,600

10 years

$206,100

15 years

$295,900

20 years

$424,800

An alternative to a reverse mortgage is a “home reversion scheme”. Under these schemes, part or all of the home is sold to a home reversion company at a discounted price (generally between 35% and 60% of what the house is worth). The retiree has the right to remain living in the home until they either die or decide to move. The two main types of home reversion schemes are as follows: (1) sale and mortgage: the retiree sells the home and the final settlement is put off until death or the retiree moves out of the home (2) sale and lease: the home is sold to the home reversion provider and leased back to the retiree.

The Australian Securities and Investments Commission (ASIC) has previously released a report into equity release products in light of increased awareness and demand for the products. The report highlights some of the issues which should be considered before entering into an equity release product: • Are there protections against excessive costs? • Who is obliged to maintain the property? • Who gets the benefits from any property renovations? • How will the product affect a person’s social security entitlements and tax liability? • Is the provider financially sound?

• What rights does the investor have if something goes wrong? ASIC, in association with MoneySmart, has also released a publication entitled “Thinking of using the equity in your home? An independent guide to using the equity in your home” (www.nfc.com.au/EquityRelease-Reverse-Mortgage-Products-source-ASIC.pdf) detailing the issues which should be taken into account before entering into a reverse mortgage.

¶12-710 Superannuation benefits for downsizing Individuals aged 65 years or over may make additional superannuation contributions from the proceeds of the sale of their main residence. The concessional treatment allows individuals aged 65 years or over to make “downsizer contributions” from the proceeds of the sale of a main residence that they and/or their spouse have owned for at least 10 years. The total amount an individual can make as downsizer contributions is the lesser of $300,000 and their share of sale proceeds from one sale of the main residence. Where a couple sells their main residence, the couple is able to contribute up to $300,000 each. A contribution qualifies as a downsizer contribution in respect of an individual if the following conditions in ITAA97 s 292-102 are satisfied: • the individual is aged 65 or older at the time the contribution is made • the contribution is in respect of the proceeds of the sale of a qualifying dwelling in Australia from a sale contract entered into on or after 1 July 2018 • the dwelling is not a houseboat, caravan or other mobile home • the 10-year ownership condition is met. Essentially, the individual and/or their spouse must have owned the dwelling for 10 or more years prior to disposal. This general rule is modified to take account of events for which the main residence CGT exemption (in ITAA97 Subdiv 118-B) provides special treatment, eg, where there may not be a dwelling at all times on land that is owned and where the dwelling and land had been compulsorily acquired • a gain or loss on the disposal of the dwelling must have qualified, or would have qualified, for the main residence CGT exemption in whole or in part • the contribution is made within 90 days of the disposal of the dwelling, or such longer time as allowed by the Commissioner • the individual chooses to treat the contribution as a downsizer contribution, and notify their superannuation provider in the approved form at the time the contribution is made, and • the individual does not have downsizer contributions in relation to an earlier disposal of a main residence. The superannuation contribution the individual makes is treated as a non-concessional contribution. The superannuation contributions are able to be made in addition to the existing rules and caps. In this regard, a contribution under this provision will be able to be made: • by an individual aged over 74 years despite failing the age test generally preventing such nonconcessional contributions (subject to the provisions of the superannuation fund itself) • by an individual aged between 65 and 74 even where the individual fails the work test, and • by an individual even whether their total superannuation balance is $1.6m or more.

¶12-800 Consequences of death on family home

In the context of wealth creation, the two most commonly asked questions in relation to death and the family home are: • does it matter to whom I leave the family home? • I have just inherited a home; what should I do with it? To answer these questions, it is necessary to understand the special taxation rules relating to homes acquired under a deceased estate. Detailed information in relation to the wealth creation aspects of succession planning can be found in Chapter 19 (specifically at ¶19-605 and ¶19-695).

FINANCIAL PLANNING FOR THE FAMILY The big picture

¶13-000

Financial goals Budgeting and goal setting

¶13-050

Budget planning

¶13-060

Cost of raising children

¶13-070

Debt management strategies Debt management

¶13-100

Myths and strategies about debt

¶13-105

Child care Child care options

¶13-200

Child care costs

¶13-205

Investing for children’s education Children’s education

¶13-300

Saving for children’s education

¶13-305

Bank account (or other at-call account)

¶13-310

Term deposits

¶13-315

Managed funds

¶13-320

Insurance bonds

¶13-325

Scholarship (education) funds

¶13-330

Direct shares

¶13-335

Additional mortgage repayments

¶13-340

Geared investments

¶13-345

Superannuation for children under 18

¶13-350

Grandparents paying school fees

¶13-355

Government assistance for education costs HECS and HELP

¶13-400

Student contribution options

¶13-405

HELP loans and repayments

¶13-410

Variations to compulsory repayments

¶13-415

Repaying a HELP debt

¶13-420

Saving for children Children’s savings options

¶13-500

Teaching children the value of money

¶13-505

Special disability trusts

¶13-510

Taxation issues relating to the income of children Taxation of children’s income

¶13-600

Excepted income of minors

¶13-605

Minor is an excepted person

¶13-610

Unearned income of minors

¶13-615

Taxation issues for trustees

¶13-620

Social security implications

¶13-625

Government assistance Government family payments

¶13-700

Paid parental leave

¶13-705

Family Tax Benefits

¶13-710

Family Tax Benefit Part A

¶13-715

Family Tax Benefit Part B

¶13-720

Income test for Family Tax Benefits

¶13-725

Child Care Subsidy

¶13-730

Grandparent child care subsidy

¶13-735

Parenting payment

¶13-740

Youth Allowance

¶13-745

Child support Child support or child maintenance

¶13-800

Child Support Scheme

¶13-805

Child maintenance trusts

¶13-810

Estate planning Estate planning for children

¶13-900

Nominating a guardian

¶13-905

Financial provisions

¶13-910

Testamentary trusts

¶13-915

¶13-000 Financial planning for the family

The big picture A young couple setting out on life’s journey will go through many life stages. Each stage requires a different financial planning strategy and goal, not only as the couple deals with the issues and expenses faced in that life stage, but also as they prepare for moving into the next phase. To cope with this journey, the ability to look ahead and plan for the next stages is critical. Not all couples will go through every stage, however, many couples will at some point progress through some of the following life stages: • Just the two of us — newly married, two incomes, no kids and saving for future expenses, such

as a home deposit, or repaying an existing mortgage • Starting a family — pregnancy and then arrival of a baby into the family, likely to be paying off a mortgage and may have dropped to one income (short-term or long-term) • Raising a young family — paying for education fees, starting to make headway with the mortgage and the homemaker may return to work part-time or full-time • Empty-nesters — children start to leave home, mortgage is well under control or repaid and planning for retirement may become front of mind • Retirement — Age Pension and/or other investments provide the main ongoing source of income and significant debts such as the mortgage have been largely repaid. There are a number of events that may occur, which are unforeseen and may have an impact on the achievement of family goals, or on the family’s capacity to maintain their lifestyle. These events may include: • Divorce, which can negatively impact plans and increase expenses as the finances stretch to support two households. It can also restart the cycle again as one or both partners remarry and start a new family. • Death or disability of one partner. Protection through life and disability insurances is a highly critical part of the financial planning process and should be included in the family budget. Life insurance is covered in detail in Chapter 7. Health insurance can also help to minimise expenses. • A responsibility at some point for aging parents or relatives. Whether it be having a frail aged parent move in to their home, or a requirement to provide some level of financial support for aged care services for example, it can be easy to overlook and fail to plan for this change. Financial goal setting is important. This requires not only good financial planning advice, but also disciplined budgeting and financial management skills.

FINANCIAL GOALS ¶13-050 Budgeting and goal setting Budgeting (or expense planning) is the first step in establishing a financial plan. It identifies sources of income and expenditure, and can also help identify areas where cost savings can be achieved. The difference between income and expenditure will show the capacity for the clients to accumulate savings. There are many budgeting tools on the internet to assist clients with the process. A budget is a living document and should continue to be reviewed and updated as circumstances change or more accurate data becomes available. When planning for a family you need to consider the different life stages and the impact on expenses. Day to day budgets may need to be adapted, as well as allowing for lump sum expenditure that may be required at each stage. This may include: • additional expenses during pregnancy, including medical costs in addition to costs which are covered by Medicare or private health insurance • setting aside funds if the family income will reduce after having a baby • making allowances for child care, and considering the costs associated with preferred future education.

At each stage, a savings component or “emergency fund” should be included either to pay for unexpected expenses or savings goals or to cover income shortfalls in future periods. The amount that a client may need to have in their emergency fund will vary, based on the life stage they are in at any given time. For example, a higher level of savings may be required when a family has young children, and relatively high levels of debt. Once established, clients must be committed to keeping within their budget.

¶13-060 Budget planning The first step to planning a budget is to determine the client’s life goals and values. They also need to set expected time frames for when expenditures or life changes may occur. Some general issues to consider in the first three life stages are discussed below. Planning to retire is covered in Chapter 15. • Just the two of us – saving for a home deposit and furnishing a home – travel plans – repayment of personal debts (cars, university HELP debts, credit cards) – deciding if and when to start a family.

Tip When getting close to starting a family or purchasing a home, the couple may wish to try living on one wage and saving the other. Not only will this give their savings a boost, but it will also provide a good test run to get a feel for how they may cope with reduced discretionary cash flow.

• Starting a family – costs associated with having a baby — this may include costs of conception (if IVF or medical assistance is needed), hospital costs (private versus public), out-of-pocket medical expenses – what government support payments are available and do they qualify – does either person or both plan to take time off from work and for how long – costs of a newborn baby — nappies, formula, medications and other medical expenses – expenses for baby equipment such as prams, cots and car seats – clothing for the baby (and not forgetting maternity clothes). • Raising a young family – does the homemaker parent plan to return to work, and if so will it be part-time or full-time and when will they return – costs of child care or a nanny – education costs and whether they plan to send the children to public or private schools for primary and/or high school (refer to ¶13-305 for more information on saving for child education)

– university fees as well as living expenses if the child needs to live away from home (refer to ¶13400 for more information on fees and government assistance) – the child’s living expenses — clothing, entertainment, food and holidays – presents and celebrations – costs of participation in sporting or other activities/hobbies such as dancing and music lessons, as well as the petrol cost to transport children to and from events. Families are unlikely to have significant surplus cash flow, especially in this last stage. However, it is easy to spend all surplus income on lifestyle and the child’s wants so a good budget is necessary to set goals, to prioritise conflicting financial needs, and to make sure plans are on track for the next life stage.

¶13-070 Cost of raising children Raising children is not a cheap exercise. A report titled “Cost of Kids” issued by the National Centre for Social and Economic Modelling (NATSEM) and AMP in May 2013 estimated that the “typical” middle income family spends approximately $812,000 (increasing from $537,000 in the 2007 report) to raise two children from birth until they complete their education and leave home. The cost of raising children depends on the family’s income, their lifestyle and priorities. The AMP/NATSEM report looked at the cost for low, middle and high income “typical” families with the costs for raising two children ranging from $474,000 to $1,097,000. The variations were largely due to different expenditure in education, recreation and food. While the cost is high, the cost does not seem to be getting higher relative to family income levels. The report found that the typical family spends 23% of its combined income on the cost of raising children, which is the same percentage spent in 2002. However, the enormity of this figure makes good budgeting and planning essential. The AMP/NATSEM report listed the average costs (in December 2012 dollars) for two children from birth until they completed education as noted below. However, the world has continued to evolve over the past seven years, and this has arguably continued to increase the costs of raising children. Technology has been a driving factor, for example, with many schools now requiring students to have laptops, tablets or other technologies. Food

$143,148

Transport

$158,955

Recreation

$100,982

Education

$44,644*

Housing

$77,996

Child care

$53,656

Fuel and power

$17,413

Clothing

$45,604

Furnishing and equipment

$50,425

Health

$44,560

Services and operations

$18,960

Other

$55,700

Total

$812,043

* This assumes education to Year 12 is at government schools and the children study for three years at university. A family that chooses private schools may spend significantly more on this item.

The cost per child was found to be directly related to the family’s income, but also changed at different ages. For a middle income family, the average weekly cost of an older child was over five times that of a younger child: Child under age 5 $133 per week Child age 18–24

$678 per week.

DEBT MANAGEMENT STRATEGIES ¶13-100 Debt management Debt management is a major component of most people’s wealth accumulation strategies, either to accumulate investments (deductible debt) or lifestyle assets such as the home (non-deductible debt). Detailed information on debt is covered in Chapter 11. For many families this is the greatest burden on finances and comprises a large portion of expenditure. It is not uncommon for the home loan repayments to use at least 30%–40% of the family’s disposable income. Non-deductible debt, such as credit card debt, in particular, is expensive debt and adds pressure to a family budget. Repayment of non-deductible debt is a low risk strategy which provides immediate savings, and without the risk of market volatility. The savings relate to the interest component, which is otherwise payable on the loan amount. The savings from repayment of non-deductible debt are not tangible when compared to accumulating savings. This can make the comparison difficult. As a general guide, if comparing repayment of non-deductible debt to a regular (non-superannuation) savings plan, the value of repaying debt can be measured as the after-tax rate of return required from an investment to pay the additional interest. The table below shows the required rate of return for an ordinary investment to return at least the same effective rate of return as the repayment of debt. This is shown at different marginal tax rates (2020/21) based on both an 8% and 4% loan interest rate.* Marginal tax rate (incl Medicare levy)

Required investment rate of Required investment rate of return – loan with 8% return – loan with 4% interest rate interest rate

21.0%

10.1%

5.06%

34.5%

12.2%

6.11%

39.0%

13.1%

6.56%

47%

15.1%

7.55%

*Based on tax rates as at 1 July 2020.

To achieve these rates of return the client needs to invest in growth investments, which carry a higher level of risk compared to reducing non-deductible debt. Repayment of non-deductible debt will also free up disposable income, once the debt is repaid. To gain the maximum value, these savings could be directed to other wealth accumulation or protection strategies, rather than just increasing lifestyle expenditure. Reviewing repayments when interest rates change Interest rate movements impact loan repayments. If interest rates rise, clients should consider their capacity to increase repayments so that the repayment goal is not extended. The lender may also require the repayments to increase. If interest rates fall, loan repayments should ideally be maintained at the

same level (even though the lender may allow a reduction) as the additional repayments reduce the outstanding principal and shorten the repayment period.

¶13-105 Myths and strategies about debt The simplest strategy is to repay non-deductible debt as quickly as possible, within the family’s budget. But strategies to get the best result are the subject of many myths. This section explores some common myths in relation to debt management. Myth 1 — Choose a credit card with an interest-free period to reduce interest costs This can be true but only if the full balance is repaid every month. If the balance is not paid in full by the due date, interest may be charged from the date of purchase. The interest rate on credit cards is higher than other forms of debt, particularly home mortgages. The key strategies to manage credit card debt include: • pay the balance in full every payment period to avoid interest charges • have a low limit to avoid the temptation to spend and do not accept automatic offers of limit increases • look for lower interest rate options (eg cards without loyalty programs) • interest-free periods — cards with interest-free periods may charge higher rates than cards which do not, but the interest-free period may only apply if the balance is paid in full each month. Therefore, if the balance is to be repaid in full, the interest-free periods may be cheaper. However, if the balance is not paid in full, the no interest-free period cards may reduce the interest costs. Clients need to decide how they will use their credit cards, and choose one that minimises their costs and temptation. In addition, for clients who cannot maintain a disciplined approach, it may not be appropriate to use a credit card to pay for monthly expenses. Although it can often make sense (sometimes with the added benefit of being able to accumulate points and rewards based on the credit card program), where the debt is not repaid each period in full, the benefits of this strategy can be negated. Myth 2 — Small changes won’t help me clear debt faster Sometimes small changes can have a significant impact on debt levels in the longer term. The faster debt is repaid, the greater the overall saving on interest costs. Interest is usually calculated on a daily basis so repayment of debt on a more regular basis can reduce the total interest cost over the life of the loan. Savings can be achieved by making repayments more frequently to reduce interest costs, ie weekly or fortnightly rather than monthly. Over a single year, the net benefit may not seem significant, however over the longer term, the benefits can be substantial — particularly when combined with other strategies, such as making small additional repayments above the minimum, and crediting salary directly into a home loan or offset account. Myth 3 — Consolidating debt into the home loan is cheaper This depends on how the client manages the consolidation and their behaviour afterwards. Consolidating different types of debt into one loan may be an opportunity to reduce the overall interest expense. For example, credit cards, personal loans and the home mortgage can be consolidated into one loan secured against the home to access a lower interest rate on the total debt. This is a simple and effective strategy but the strategy will fail if the client continues to spend and build up new debt on their credit card. Clients should consider cancelling credit cards or lowering the credit limit. While consolidation may offer access to a lower interest rate to provide interest savings and also free up disposable income, combining personal debts onto the home loan may extend the repayment period for these amounts. It is worth determining a reasonable time frame to pay off the additional debts and increase the loan repayments accordingly.

Example Claire has the following debts:

Type

Loan balance

Remaining term

Interest rate pa

Monthly repayment

Home loan

$200,000

25 years

4.5%

$1,122

Personal loan

$20,000

7 years

9.5%

$329

Claire pays a total of $1,451 per month in loan repayments (including a $10 per month in fees). She can reduce this expense by consolidating her personal loan onto her home loan, with the total of $220,000 to be paid over the next 25 years. This also reduces the interest on this debt to the lower home loan rate of 4.5% per annum. Total monthly repayments reduce to only $1,233 (including $10 per month in fees). But over the 25-year repayment period, the interest paid on the $20,000 totals $13,350 compared to only $7,458 (inclusive of fees) if she kept the seven-year period as a personal loan. (Projections Based on MoneySmart Mortgage Calculator: moneysmart.gov.au)

Tip Claire could calculate the repayment needed to still pay the $20,000 over a seven-year period at the lower home loan rate, and increase her repayments by this amount to keep the interest costs to a minimum.

Myth 4— Buying is better than renting The attraction of buying is to have control over where you live and the ability to personalise your home. Most people also see it as a good investment as you eventually own a substantial asset. But is it a better financial strategy than renting and investing the savings which come from the difference between rent and home loan repayments? Like most debt management strategies, it depends on the client’s behaviour, discipline and expectations. The issues to compare include: • clients can generally upgrade their lifestyle by renting rather than buying as they can afford to rent a better quality accommodation. But this will eat into some of the strategy savings • home ownership comes with many hidden expenses which many clients do not factor into the financial comparison. These include maintenance, upgrades to kitchen, etc, curtains and other furnishings • the rent and invest option requires discipline to calculate the savings and to invest appropriately. This includes a recalculation every time rents and/or interest rates change • the total return that can be achieved in each option taking into account income, capital appreciation and expenses.

CHILD CARE ¶13-200 Child care options Availability of high quality, affordable child care is an important issue for families who also work part-time of full-time. Government assistance may be available to help with the costs (¶13-740). Parents have a number of options available depending on affordability, availability and preference for the type of care. Private nanny — employed on either a live-in or live-out basis (including on a shared basis). Duties are generally restricted to child care and related domestic tasks. Nannies do not need to have any formal training but it may be preferable to find someone with experience. Costs can be reduced by sharing a

nanny with other families. Long day care — long day care centres are available for children under school age to provide all-day or part-time care. Meals may also be provided. They may be run by private operators, local councils, community organisations or employers. Family day care — family day care is a network of experienced carers who provide care and developmental activities in their own homes for other people’s children. It is usually available for children under school age but may also provide after-school care for school children up to age 12. Care is flexible and can be tailored to suit each family’s needs, including care outside normal working hours. Pre-school/Kindergarten/Prep — the name will vary across states but it is an educational program for children usually aged between three and five. Pre-school operates on hours similar to school hours, although this may vary by state and by service. Before/after-school care or Out of School Hours (OOSH) care is supervised care and recreation for school-age children: • before and after school • on pupil-free days • during school holidays (vacation care). OOSH care is usually connected to primary schools and is operated by community and private organisations. The government’s program is known as Outside School Hours Care (OSHC) or Vacation Care (VC). Occasional care services — occasional care services provide short periods of care for children under school age on either a regular or irregular basis. Parents use occasional child care for a variety of reasons, including casual, shift-work or part-time work, respite care, crisis and emergency care, shopping or attending appointments. Employer-provided child care — employers are increasingly recognising the benefits that flow to both business and its employees from employer-sponsored child care initiatives. If an employer provides an approved child care facility on its business premises, the cost can be salary packaged as a fringe benefits tax (FBT) exempt item (¶10-600). This is a valuable planning tool as it allows the parent to pay for child care from pre-tax money.

¶13-205 Child care costs The costs of child care can vary across states and providers. The table below provides a rough guide of expected average fees to parents. Care type

Cost guideline

Nanny — live in

$17–$25 per hour + agency costs

Nanny — live out

$17–$35 per hour + agency costs

Nanny — sharing

$17+ per hour per family + agency costs

Long day care

$70–$188 per child per day

Pre-school

$45–$80 per child per day

Family day care

$7.50–$16.80 per child per hour

In home care

$20–$25 per hour

Outside of school care

$15–$45 per child per session

Source: www.careforkids.com.au, published 31 December 2019.

INVESTING FOR CHILDREN’S EDUCATION ¶13-300 Children’s education Annual school fees for each child range from a couple of thousand dollars a year up to over $20,000 plus per child at elite private schools. And this is before the cost of books, uniforms and other school-related expenses. Costs can be minimised by choosing a school with lower fees but, to provide children with a good education, it will cost money at any level. The level a family chooses depends on their affordability, education values, access and location of schools and the child’s needs. Parents need to decide what type of education they want and can afford at each level of education. For example, to reduce costs parents may plan to send children to a government school or lower fee catholic school in the primary school years and then to a more elite school for high school years.

¶13-305 Saving for children’s education Children’s education is becoming more expensive and can have significant financial impacts for a family. These impacts can be lessened or managed with a strategy for funding the expenses. It is important to consider both primary and secondary education costs and to plan for these expenses, as well as the impact on future cash flow as early as possible, regardless of whether there is a preference for public of private education. Saving for children’s education uses the same principles as any other savings strategy. But as the education purpose sets a savings goal and a time frame, it may also offer some unique investment opportunities. The first steps in the plan are to decide how much is needed and when. The calculation of how much is needed should include: ☑ school fees ☑ private tuition ☑ uniforms — summer, winter and sport ☑ books, stationery and technology ☑ school excursions ☑ extra curricular activities — such as music and dance lessons and any instruments or equipment ☑ school holiday care or expenses. The Australian Scholarships Group has estimated that a child born in 2019 could have total education costs from prep through to year 12: • of up to $78,232 for government education, and • up to $351,684 for a private education. For metropolitan Australia ASG has estimated that annual schooling costs in 2019 were approximately: • $3,945 for primary education in a government school • $5,045 for secondary education in a government school

• $12,825 for primary education in a private or independent school, and • $24,105 for secondary education in a private or independent school. For families with more than one child, it becomes even more important to plan for these expenses. Some general principles to consider when saving for education costs include the following: • The earlier you start the greater the opportunity to build the nest egg. Even small, regular savings can accumulate to large amounts given enough time. • Consider in whose name to invest — parent or child, as this has implications for taxation as well as control. • Appropriate investment product — depends on the amount and regularity of savings, tax positions, time frame and risk profile. • Gearing may give the savings plan a boost but also increases the risk levels and requires a longer time frame. Investment options There are numerous investment vehicles available to facilitate saving for a child’s education. The option that is selected will depend on many factors, including the client’s savings capacity, investment time frame and risk profile.

¶13-310 Bank account (or other at-call account) A bank account is the simplest option as it is low risk and easily managed. It may also be the starting point for a longer term savings plan, for example, to save the initial contribution for investment in a managed fund. Advantages

Disadvantages

– readily accessible

– no hedge against inflation

– capital secure*

– low earnings potential

– low or no minimum investment requirements

– interest is fully taxable

– add additional amounts any time – can be held in name of child or parent – low or nil fees – no capital gains tax if the account is transferred into the name of the child in the future. *A cap of $250,000 per person, per institution on deposits guaranteed under the Financial Claims Scheme.

¶13-315 Term deposits Term deposits provide another low risk investment option, but with the potential for higher interest than a transaction account. Advantages

Disadvantages

– capital secure*

– no hedge against inflation

– low or no minimum investment requirements

– low earnings potential (especially for small investment amounts)

–provides discipline as generally locked into term

– early termination penalties

with penalties for early exit – interest can be capitalised

– cannot add additional amounts during term

– can be held in name of child or parent

– interest is fully taxable

– low or nil fees – no capital gains tax if the account is transferred into the name of the child in the future. * A cap of $250,000 per person, per institution on deposits guaranteed under the Financial Claims Scheme.

¶13-320 Managed funds Managed funds provide access to growth investments with the potential for a higher return but this also comes with a higher risk potential. Managed funds generally also provide flexibility to select an investment option which suits the client’s time frame and risk profile. Advantages

Disadvantages

– investment choice to suit time horizon and risk profile

– entry fees and ongoing management costs

– generally readily accessible (liquidity restrictions may apply in some situations)

– subject to market risk and volatility

– diversification — across managers, asset classes and investments

– need longer time frame to ride out periods of volatility

– growth potential (depending on investment option)

– minimum investment requirements for initial investment and additional amounts

– taxation concessions from franking credits, capital gains discounts and tax-free distributions (depending on investment option)

– cannot be held directly in name of minor child (may be held in the name of parent or guardian as trustee for the child)

– can invest additional amounts (periodically or regular savings plan)

– depending on how the account is established, capital gains tax may be payable in the future if the investment is transferred to the child in the future

– provider makes the buy/sell decisions on underlying assets

¶13-325 Insurance bonds Insurance bonds are life insurance products with a savings component. They operate similarly to a managed fund (unit trust), but with different taxation implications as the taxation is payable at the life company level. Advantages

Disadvantages

– investment choice to suit time horizon and risk profile

– entry fees and ongoing management costs

– growth potential (depending on investment option)

– subject to market risk and volatility

– earnings taxed within fund at 30% (which may be – need longer time frame to ride out periods of lower than parent’s marginal tax rate) with no volatility impact on client’s tax return unless withdrawal made in first 10 years

– amounts can be withdrawn tax-free after 10 years

– minimum investment requirements for initial investment and additional amounts

– readily accessible (liquidity restrictions may apply – tax paid within the fund at up to 30% and no in some situations) discount for capital gains — this may be higher than the parent’s marginal tax rate – can invest additional amounts within 125% rule (periodically or regular savings plan)

– tax may be payable on benefit if withdrawn within first 10 years

– provider makes the buy/sell decisions on underlying assets

– additional amounts are limited to 125% of the previous year’s deposit to avoid recommencing the 10-year term – limited number of providers in the market place

¶13-330 Scholarship (education) funds Scholarship or education funds are currently offered by several friendly societies and are purpose-built to save for a child’s education with some specific tax concessions. These products are friendly society bonds so the tax is paid by the company at the rate of up to 30%. While the money remains in the fund, the earnings do not have to be declared on either the parent or child’s tax return. Withdrawals from the fund are taxed to a child under 18 as unearned income (see ¶13-615 for tax rates). Over age 18, the adult marginal tax rates apply. But the ATO has granted special rulings to allow the tax to be refunded on amounts withdrawn if used to pay education benefits, even if the money has been invested for more than 10 years. Education expenses include uniforms, travel costs, fees, books, materials, living-away-from-home allowance and residential boarding expenses. The operation of the funds can vary greatly between providers, so it is important to understand the features of any product considered including what amount is returned to the parent if the proceeds are not used for educational purposes (eg the child dies or decides not to continue study) or if the parent decides to exit the fund early. Some funds keep a separate account for each client and all contributions plus earnings will eventually be returned to the investor. Other funds may use a pooling arrangement to pay a scholarship to the student, so if the child does not advance to that education level, only contributions are returned. These products have become more flexible than in previous years, with some products offering a range of investment choices. Advantages

Disadvantages

– investment choice to suit investment horizon and – penalties can apply if funds are not used for risk profile (depending on product) educational purposes – growth potential (depending on investment option)

– savings plans may need to commence by a particular age for different levels of study

– regular contributions at a level that suits the family budget

– contributions may be inflexible if family circumstances change

– provides strong savings discipline

– fees and charges should be considered (particularly for an early exit)

– earnings taxed within fund at 30% (which may be – subject to market risk and volatility lower than parents’ marginal tax rate) with no impact on client’s tax return unless withdrawal made in first 10 years

– in cases where a special tax ruling is available, tax paid can be refunded at “maturity” if used for education purposes

– need longer time frame to ride out periods of volatility

¶13-335 Direct shares Direct shares are generally most suitable for a long-term investment (five years plus) and may provide taxation advantages as well as a greater earnings potential. Shares are easily bought and sold, with a high level of liquidity and flexibility. Advantages

Disadvantages

– growth potential to hedge against inflation

– limited diversification achievable for small investment amounts

– taxation concessions from franking credits and capital gains discounts

– brokerage fees to buy and sell can be relatively high on small holdings

– opportunity for diversification (across companies and industry types)

– subject to market risk and volatility

– high levels of liquidity

– need longer time frame to ride out periods of volatility

– can purchase additional shares (but see disadvantage on costs)

– minimum investment requirements for some parcels of shares

– can be held in name of either parent or the – need to monitor market closely to make buy/sell parent as trustee for the child (which may be decisions beneficial from a capital gains tax perspective when shares are transferred to the child when they are 18).

¶13-340 Additional mortgage repayments As discussed at ¶13-100 making extra repayments on the home mortgage can be a low risk and taxeffective savings method. While this strategy can work well to reduce the term of the mortgage and free up disposable income earlier, it can also work as a savings plan. Instead of using an investment product to save for children’s education, the parent can make extra repayments onto the mortgage, and then draw back down when needed. It is important to check that a redraw facility is available. This will generally not be available on fixed rate loans. Further to this point, if this strategy is used as a savings vehicle, it is important before fixing any portion of the loan in the future, to understand whether this is likely to impact the future accessibility of any additional repayments that have been made. An alternative may be establishing an offset account, to reduce the balance of the loan upon which ongoing interest liability is calculated. The downside of this strategy is determining how much the “savings plan” has accumulated to, as no interest earnings are added and there is not a discrete balance to monitor. While the net return of this strategy is broadly equal to the interest rate of the home loan, some people prefer and are motivated by being able to “see” an accumulating savings account balance. If all surplus cash flow and savings for other purposes are diverted to the same offset account or redraw facility, it can become difficult to manage, and discipline becomes necessary to maintain the savings plan. Parents may wish to keep a nominal set of records showing how much they deposited and how much interest they saved, to gauge how much they have saved towards their child’s education. Advantages – low risk

Disadvantages – minimum investment requirements for initial

investment and additional amounts – can be used for any time frame

– may not be practical for a fixed rate loan due to limits on extra repayments and exit penalties – may be costs associated with each redraw made

– readily accessible if redraw facility is available

– does not have an account balance or ability to maintain “sub-accounts” to track value of savings

– no entry fees or ongoing investment management costs

– investment does not grow, value of savings is in reduced interest on loan

– effectively creates tax-free returns through interest savings on mortgage – can invest additional amounts (periodically or regular savings plan) – money can be used for any purpose

¶13-345 Geared investments A gearing strategy (¶11-000) can be undertaken for investments held in a parent’s name. This could be either a lump sum gearing strategy or instalment gearing to gradually build the investment over time. Gearing increases the level of risk associated with a strategy but can leverage the potential returns and provide greater diversification. Careful consideration must be given to whether the risk/return trade-off is worthwhile and necessary. Cash flow should also be carefully considered to ensure that cash is readily accessible in the event that a margin loan is established, the value of investments fall, and a margin call is received.

¶13-350 Superannuation for children under 18 Contributions can be made into superannuation on behalf of a child under age 18. The amount of contributions is limited by contribution caps (¶4-220 to ¶4-240). This strategy can help establish a comfortable retirement for the child as the power of time and compound interest can build the contributions into substantial retirement savings. This may enable the parent or grandparent to give a gift with a much greater value to a child than saving money outside superannuation as, say, a 21st birthday present, but with a very extended investment time frame. As a contribution to super will be preserved until the child meets a condition of release, this type of investment is therefore not appropriate for purposes such as saving for education costs. Given the very long investment horizon as a result of the conditions of release, considerable thought should be given as to the appropriateness of superannuation as an investment for children. Also, as contributions are made based on the accessibility rules that exist at the time, this type of investment comes with legislative risk, as the super rules may change over the life of the investment. It may be possible for a child under the age of 18 to make voluntary contributions to super (for example with savings received from gifts), for the purpose of saving for a first home. Eligible voluntary contributions and associated earnings (calculated at a set rate) may be released after they reach the age of 18, for the purpose of paying a deposit on a first home (for more information on the First Home Super Saver (FHSS) Scheme see ¶4-222). Advantages

Disadvantages

– disciplined savings (due to restrictions on access)

– contributions limited to specified caps

– wide investment choice (depending on superannuation fund)

– legislative change may alter accessibility rules

– growth potential (depending on investment option) which can provide hedge against inflation

– generally will not be accessible until retirement after age 60 (preservation age is currently 60 for people born from 1/7/1964)

– exempt from social security while under Age Pension age

– entry fees and ongoing management costs – investment earnings are taxed at up to 15% in super accumulation, which may be greater than the child’s marginal tax rate

– earnings taxed within the fund at a maximum rate of 15% – can invest additional amounts (within contribution caps) – provider makes the buy/sell decisions on underlying assets (unless they are direct investments in a self managed fund)

¶13-355 Grandparents paying school fees In many family situations, the grandparents may choose to pay the school fees as a way of helping the family financially. The payment of fees will be considered a gift and will be assessed under the gifting rules if the grandparents receive social security benefits, or receive certain types of home care or residential care services (¶6-670). Paying the fees on an annual basis may lessen the impact on their Age Pension and aged care fees, compared to gifting a lump sum to invest for future school fees (depending of course on the amount paid, as well as any other gifts the grandparents make). Grandparents may also be interested in paying the school fees in the hope that this establishes the grandchild as a financial dependant for superannuation purposes. If a grandchild could demonstrate financial dependence on the grandparent at the time of death, this could allow the grandchild to receive superannuation benefits and to receive the benefits as a tax-free lump sum (or as a death benefit income stream if eligible, where tax may or may not be payable on pension payments received). However, case law suggests that establishing financial dependency for superannuation purposes is onerous, and payment of school fees and other reasonably common expenses is generally insufficient to establish financial dependency. Grandparents receiving social security benefits who wish to pay for a grandchild’s education expenses need to consider the allowable gifting thresholds and the potential for the deprivation rules to be applied. See ¶6-670.

GOVERNMENT ASSISTANCE FOR EDUCATION COSTS ¶13-400 HECS and HELP University fees (contributions) can be paid each year or, alternatively, assistance through a loan scheme may be provided by the government. Prior to 1 January 2005, the government offered several loan schemes to students. Debts accrued under these schemes were collectively called HELP debts. The Higher Education Loan Program (HELP) replaced all the previous schemes from 1 January 2005. HELP is divided into three schemes: • HECS-HELP — for eligible students enrolled in Commonwealth supported places • FEE-HELP — for eligible fee paying students enrolled at an eligible higher education provider or Open Universities Australia

• OS-HELP — for eligible Commonwealth supported students who wish to study overseas. The person can make repayments on their HELP debt under the following situations: • compulsory repayments when income exceeds the minimum thresholds (paid through the person’s tax return at the end of the year or by asking the employer to deduct additional Pay As You Go (PAYG) withholding amounts throughout the financial year) • voluntary repayments (which may be payments in addition to the annual minimum repayment levels, or where the person’s income is below the threshold above which repayment is required). Interest is not charged on the loan but outstanding HELP debts are indexed on 1 June each year to the March Consumer Price Index (CPI). Indexation is applied to any debt that has been unpaid for at least 11 months. The indexation rate for 2020 is 1.8%. Additional information on HELP can be found at: • www.ato.gov.au • studyassist.gov.au

¶13-405 Student contribution options The student contribution is the amount payable per unit of study at university. Students have several options they may wish to consider for payment: (1) Pay the full amount upfront. This avoids accumulating a HELP debt.* (2) Make a partial upfront payment plus accumulate a partial HELP debt.* A combination of upfront payments and accumulation of a HELP debt for the balance can minimise the debt accumulating. (3) Defer payment of the student contribution and accumulate a HELP debt. In many cases it may not be affordable to pay the student contribution upfront and a HELP debt will be accumulated. This may be the only option available. * The discount applying to upfront payments and voluntary payments was abolished from 1 January 2017.

Note Amounts paid by an employer are subject to fringe benefits tax.

Paying for a child’s student contribution Depending on a parent’s financial situation (and often how much has already been spent on education), parents may assist in paying the full amount of the student contribution upfront. This avoids the child accumulating a HELP debt. If parents need to borrow funds to pay the student contributions, the cost should be considered in light of the indexation of the outstanding loan to determine if this is viable. The HELP loan is only indexed to CPI which may be lower than interest rates on commercial loans.

¶13-410 HELP loans and repayments Eligible students enrolled with approved Australian education providers may be able to apply for a HELP loan to assist with the costs of education.

The loan provided by the government is repaid either via voluntary repayments, or amounts withheld from the person’s salary once certain levels of income are earned. Maximum loan amount On 1 January 2020, some changes were made to student loan limits. There is now a “combined HELP loan limit” of: • $106,319 for most students, or • $152,700 for students studying certain qualifications such as medicine, veterinary science or dentistry. The loan is renewable, which means that any repayments (voluntary or compulsory) will reduce the loan balance and therefore the amount that counts towards the cap, enabling additional loan amounts to be drawn if eligible. The loan balance takes into consideration HECS-HELP, FEE-HELP, VET FEE-HELP and VET student loans. Loan balances can be checked via myhelpbalance.gov.au. Income assessed to determine repayments Regardless of whether a person is continuing to study compulsory repayments must be made on a sliding scale once the student’s income exceeds the HELP repayment income (HRI)* specified by the ATO. HRI is: Taxable income Plus

Total net investment losses

Plus

Reportable fringe benefits

Plus

Exempt foreign income

Plus

Reportable superannuation contributions (eg salary sacrifice)

*Higher Education Support Act 2003 s 154-5 .

Overseas residents Those who have a debt and reside overseas have the same repayment obligations. The repayment requirements apply to all debts — both existing and future. Since 1 July 2017, compulsory repayments are determined based on “worldwide income”. Worldwide income is: • HELP repayment income (see above) plus • foreign-sourced income (converted into Australian dollars). If this income exceeds the threshold levels a repayment is required. Individuals have until 31 October each year to provide the following details to the ATO in relation to the prior financial year: • residency status • worldwide income. Overseas residents can also make additional voluntary payments. Individuals who have HELP debts and: • live overseas, or • intend to move overseas for 183 days or more in any 12-month period

are required to update their contact details with the government within seven days of leaving Australia. This must be completed via myGov. The income thresholds for the 2020/21 financial year are shown in the table below: HELP repayment income (HRI)

Repayment rate % of HRI

Below $46,620

Nil

$46,620–$53,826

1.0%

$53,827–$57,055

2.0%

$57,056–$60,479

2.5%

$60,480–$64,108

3.0%

$64,109–$67,954

3.5%

$67,955–$72,031

4.0%

$72,032–$76,354

4.5%

$76,355–$80,935

5.0%

$80,936–$85,792

5.5%

$85,793–$90,939

6.0%

$90,940–$96,396

6.5%

$96,397–$102,179

7.0%

$102,180–$108,309

7.5%

$108,310–$114,707

8.0%

$114,708–$121,698

8.5%

$121,699–$128,999

9.0%

$129,000–$136,739

9.5%

$136,740 and above

10.0%

When commencing employment in Australia, individuals must state in their TFN declaration form that they have an outstanding HELP debt. If income exceeds the minimum compulsory repayment levels, higher withholding tax amounts must be deducted. Self-employed individuals may be subject to PAYG instalments. Overseas residents are required to provide details of worldwide income for an assessment to be made by the ATO. Amounts withheld through PAYG do not automatically offset an outstanding HELP debt. The additional withholding amounts form part of the total tax withheld for the financial year. These amounts are reconciled at the end of the year when the ATO calculates how much tax, Medicare levy and compulsory HELP repayments are payable. If the individual has had the correct amount of tax and compulsory repayments withheld from their income, the person will either receive a refund of excess tax paid or an assessment for any extra tax payable. Directing any amount of tax refunded to making additional HELP repayments would be at the individual’s discretion. HELP debts and bankruptcy HELP debts are still fully repayable if the person becomes bankrupt. HELP debts upon death An outstanding HELP debt is cancelled upon a person’s death. The trustee or executor of the deceased’s estate is required to lodge a tax return for the part of the financial year the person was alive. If any

repayments were required in that period, it is payable by the estate. Any outstanding amount from the date of death is cancelled.

¶13-415 Variations to compulsory repayments Low family income If a person has a spouse or dependant and is eligible for a reduced Medicare levy (or exemption) due to low family income, the person is also exempt from making a compulsory HELP repayment in that financial year. A person who is eligible for this exemption can request that their employer does not withhold compulsory repayments through PAYG for that financial year. Financial hardship In situations of serious financial hardship or under other special circumstances, an application can be made to the ATO to defer payment. Voluntary HELP repayments — abolished Prior to 1 January 2017, a 5% voluntary repayment bonus was available to individuals who made lump sum voluntary HELP repayments. Although the bonus is no longer available to individuals who make voluntary repayments, additional repayments may still be made above the compulsory levels. The opportunity cost of making repayments should be considered (see below).

¶13-420 Repaying a HELP debt There are a number of considerations when determining whether to repay a HELP debt. Before considering options with HELP debts, it is important to ensure the current outstanding amount is known. Details can be obtained at any time during the year by contacting the ATO or visiting myhelpbalance.gov.au. The following are some of the issues to consider: • Financial resources Does the person have the financial capacity to repay the debt? It is generally not worth borrowing to repay a HELP debt as the interest rate will generally be higher than the CPI indexation. • Voluntary repayments Indexation is applied to the outstanding HELP balance on 1 June each year. If a voluntary payment can be made prior to 1 June, it avoids indexation being applied to that amount. Only the lower outstanding amount will have indexation applied. The indexation rate applied on 1 June 2020 was 1.8%. • Compare the alternative options to repaying HELP debt? If the person has other debts, such as a personal loan or mortgage where the rate of interest is high relative to the rate of indexation of the HELP debt, consideration should be given to directing additional funds towards these loans instead of voluntary HELP payments. It should also be remembered that once a HELP debt has been repaid, a person cannot again draw down on this debt (with the exception of accessing additional loan amounts to complete approved courses), and access to the capital will be lost.

SAVING FOR CHILDREN ¶13-500 Children’s savings options Most people’s money values are learnt quite young and are learnt from their parents. Gradually schools are also starting to introduce courses on money management skills into school curriculums but it is still the skills that a child will learn at home that are important.

¶13-505 Teaching children the value of money Good money skills can make a difference to a person’s lifestyle and family situation. It is important to teach children the value of earning, saving and spending, as well as good debt management. In particular it is important to help children understand how small amounts saved over time can add up to significant amounts. Example The chart below shows the effect of compound interest on a regular savings plan of $50 per month, earning a net return of 8% per annum. In early years most of the savings comes from the capital invested, but in each period the amount of earnings accumulates more rapidly.

There are a number of strategies to teach children the value of money, including: • earning pocket money — for example, chores must be completed to receive pocket money • savings plans — set rules such as the child must save half of the purchase cost for items they want (eg game console) • teach children that there are limits on what you can buy and the cost of debt • start an investment plan — if a child has a part-time job, encourage them to save a portion of each pay into a bank account and consider buying shares or investing into managed funds as the amount builds up • buy a small share portfolio for the child and encourage the child to monitor the performance and help with decisions to buy or sell • take a portion out of the child’s pay from a part-time job to get the child used to paying “tax”. This amount can be invested into a savings plan for the child.

¶13-510 Special disability trusts Special disability trusts were introduced so that parents and immediate family members can gift money into the trust for the support of a disabled child without triggering the social security deprivation provisions and impacting their own pension entitlement. Concessionally treated gifts are limited to a total of $500,000 (unindexed) per principal beneficiary, and the disabled beneficiary receives an asset test exemption for up to $694,000 of trust assets (for 2020/21). If the primary residence of the beneficiary held within the special disability trust, the value will not be included in the assets of the trust. Income distributed from the trust to the principal beneficiary is also exempt from social security means testing for the principal beneficiary. To receive the special treatment, a special disability trust must satisfy specific rules at establishment and on an ongoing basis, regarding: • the beneficiary • trust purpose

• trust deed and trustee • trust property • reporting and audit. Trust expenditure must be related to meeting the care and accommodation costs of the primary beneficiary, or other services required in connection with the person’s disability. A limit applies to “discretionary spending” which doesn’t align with disability related needs. A special disability trust provides an opportunity for parents and immediate family members to gift assets during their lifetime for the specific care of a disabled child without impacting government support payments. Further information on special disability trusts can be found at ¶6-620 and ¶19-300.

TAXATION ISSUES RELATING TO THE INCOME OF CHILDREN ¶13-600 Taxation of children’s income When determining whether income from an investment made on behalf of a minor is taxed in the hands of the child, the adult who has invested on the child’s behalf, on in some circumstances, the trustee of a trust on of which the minor is a beneficiary, there are a number of considerations. Higher tax rates will generally apply to income earned and taxed in the hands of a minor, unless: • the income is classified as “excepted income” (¶13-605), or • the minor is classified as an “excepted person” (¶13-610). A minor is defined as a person: • under the age of 18, and • not married, or • not working full time (in employment, trade or business) at the end of the financial year (or for at least three months during the financial year). Income which is classified as “unearned” (¶13-615) is generally taxed at the higher minor rates.

¶13-605 Excepted income of minors Excepted income of a child is taxed at ordinary (adult) marginal tax rates (¶1-070). Examples of income that are classified as excepted income and taxed at ordinary marginal tax rates include: • taxable pensions or payments from Services Australia or the Department of Veterans’ Affairs • compensation • income earned from personal exertion • income of the child from a deceased person’s estate or the investment of estate assets to which the child was entitled, which have been invested on behalf of the child • income from property transferred to the minor as a result of the death of another person or family breakdown, or income in the form of damages for an injury they suffer • income from their own business

• income from a partnership in which they were an active partner • net capital gains from the disposal of any property or investments listed above, and • income from the investment of any of the amounts listed above. In addition, amounts received from superannuation as either lump sums or income stream payments (which may be from the care not subject to the higher rates of minor tax).

¶13-610 Minor is an excepted person A minor who is an “excepted person” will be taxed at the ordinary adult rates on all of their income, regardless of the source. If the minor is not classified as an excepted person, then the higher minor rates will apply to all income which is not “excepted income” (¶13-605). A minor may be an excepted person where: • full time study has been completed, and the minor is engaged in “full time employment” (for this purpose) • the minor has a specific disability, or • is entitled to a double orphan pension.

¶13-615 Unearned income of minors Unearned income of a child (minor) is taxed at higher penalty tax rates. Unearned income may include income which is “passive income” such as: • interest • distributions from a discretionary trust • dividends, and • income from assets held in a testamentary trust, where the asset did not pass into the trust from a deceased estate. This applies to non-testamentary assets transferred on or after 1 July 2019. Income $0–$416 $417–$1,307

Rate of tax Nil 66% the excess over $416

$1,308 and over 45% on all unearned income

Note A minor child is not eligible for the low income earners tax offset or the low and middle income earners tax offset on unearned income (¶1-355, ¶1-350). Certain unearned income is still eligible to receive the offset such as income from a deceased person’s estate. The higher rates are designed as a disincentive for parents to invest money in a child’s name. Ownership of any investments (particularly the parent saving to pay for school fees) is an important consideration to avoid paying high rates of tax.

Note A child may be liable for PAYG instalments. Further information on PAYG instalments is found at ¶1105.

¶13-620 Taxation issues for trustees When money is held “as trustee” for a child under an informal trust arrangement, the ATO is focused on ensuring the most appropriate person pays tax on the income of the investment. This section discusses the general taxation implications for informal trust arrangements. Clients investing for children should ensure they receive tax advice from a registered tax agent to confirm their tax liability. Whose tax liability? Many investments will be held in the name of the parent as trustee for the child, rather than in the child’s name directly. Generally, if it can be demonstrated that the money is held in trust for the benefit of child, then the tax liability will attach to the child. This takes into account issues such as how any withdrawals are used, whether the earnings are reinvested or withdrawn and intentions for the money. Tax Determination TD 2017/11 provides the ATO’s view on the assessment of certain income earned on bank accounts. The determination provides that income earned on bank accounts will be assessable in the hands of the individual who is determined to have beneficial ownership of the funds. “Beneficial ownership” will be determined by considering: • who was the source of contributions to the account • how the funds were drawn upon and by whom, and • how the funds were used. Income tax and TFNs Most investments need a tax file number (TFN) quoted to avoid tax being withheld at the highest marginal rate. Where the investment is held in trust for a child, the trustee should quote their own tax file number. This creates a data mismatch at the ATO as the income is attached to the trustee’s TFN; however, it may not be declared in that person’s tax return. If queried by the ATO, the trustee may need to provide details of the circumstances. The ATO may wish to investigate where the money originated from and who uses the savings to identify the true owner and liability for income tax. It may be simpler to obtain a TFN for the child and quote this number instead of the trustee’s TFN. Certainly if the investment is to be held in the child’s name a TFN may be required. Capital gains tax If the investment is solely held in trust and the child effectively has beneficial ownership, the ownership title can transferred to the child (eg upon turning 18) without creating a CGT event. This is because beneficial ownership has not changed. The child inherits the cost base from the trustee and will pay CGT on ultimate disposal.

Note If the trustee has been declaring the investment income in their own tax return, the ATO may consider the transfer is a change in beneficial ownership that triggers CGT.

¶13-625 Social security implications

The trustee holding savings on behalf of a child “as trustee” should consider the impact on any government support payments. Consideration needs to be given not only as to the social security implications for the child as beneficiary, but also for any person acting as trustee or appointer. Again, the issue of control is one of the key determining factors. Centrelink will also make an assessment based on the “source” of the funds (¶6-620). The social security implications should be considered not only in relation to informal trust arrangements, but extend also to circumstances where a formal trust has been established, of which the child is a beneficiary. This may include where the child is a beneficiary of a testamentary trust. Income derived by a child can also have an impact on the issue of “dependency” for Family Tax Benefits purposes (¶13-710).

GOVERNMENT ASSISTANCE ¶13-700 Government family payments The government provides a number of benefits to families to assist with the costs associated with having a child, and raising a family. Services Australia (formerly the Department of Human Services) administers several payments. Some of the key payments include: • Paid Parental Leave • Newborn Upfront Payment and Supplement • Family Tax Benefit (Part A and B) • Child Care Subsidy (CCS) • Parenting Payment.

¶13-705 Paid parental leave Eligible parents (the primary carer) may receive the national minimum wage ($753.80 as at 1 July 2020) for a maximum of 18 weeks in the first year after the birth or adoption of a child. The first payment can be made from the child’s date of birth at the earliest. For children born or adopted from 1 July 2020, a choice will be available to provide additional flexibility to parents in the way in which they utilise their paid parental leave entitlements. Parental leave pay will be available from 14 September 2020 as: • a paid leave period of up to 12 weeks, and • 30 “flexible paid parental leave” days which may be taken as connected leave, to provide a continuous leave period of 18 weeks. Eligibility To be eligible for the scheme the person must: • satisfy the work, test (which is broadly based on the 13-month period before the child is born) • meet residency requirements • have personally received adjusted taxable income of $150,000 or less in the earlier of either financial year either before the child is born/adopted, or the date of claim • be the primary carer of the child (some exceptions apply — for example where the applicant is the partner of the primary carer and certain conditions are met), and • not be working during the paid parental leave period (with the exception of “Keeping in Touch” days,

provided they do not occur within the first two weeks of the birth of the child). Taxation of payments Parental leave payments are taxable. The primary carer has the option to salary sacrifice the amount if offered by the employer (eg salary sacrifice to superannuation). a) Work test requirements A work test must be satisfied as part of the eligibility criteria. This test relates to work in the 13-month period prior to the child’s birth. The assessment determines whether qualifying work has been performed: • across 295 consecutive days (approximately 10 months) during this period, and • that at least 330 hours of qualifying work (approximately one day per week) was performed during this period. Breaks between consecutive working days during the work test period may be permitted. Maximum permissible gaps between wording days during the test period are: • 8 weeks for births or adoptions before 1 January 2020, or • 12 weeks for births or adoptions after 1 January 2020. Qualifying work includes work performed as an employee or self-employment on either a full-time, parttime or casual basis. This can include days where a person is on paid leave (such as annual leave, sick leave or carers leave) but is in a continuing employment arrangement. Unpaid leave only meets the work test requirements in limited circumstances. Passive income earned for activities where there is no associated physical exertion or volunteering do not meet these requirements. Exceptions may apply in the event of a premature birth, complications or pregnancy related illness, or where the person ordinarily works in a dangerous job. Evidence will need to be provided to Services Australia for an exception to apply. b) Returning to work A “return to work” test will apply to determine ongoing eligibility after the child is born or adopted. An assessment will be made if the primary carer has returned to work and may become ineligible to receive payments. Working is defined as working an hour or more on a day for financial benefit (ie paid work). Some exceptions apply in extenuating circumstances for paid parental leave to continue where work has resumed (including where the child was stillborn, where a child is in hospital and in the case of selfemployed people, where very specific ad-hoc activities are performed for what is defined as a “permissible purpose”). Paid work is permitted in certain circumstances to allow primary carers to keep in touch with the workforce. These are referred to as “Keeping in Touch” days. This provides flexibility to primary carers to engage in their previous employment in order to facilitate a return to work. Keeping in touch days include attending conferences, training days and planning days. Keeping in Touch days do not impact eligibility for Paid Parental leave and will not extend the Paid Parental Leave period. They cannot occur within the first two weeks of the birth or adoption of the child. It is not a requirement to tell Services Australia when a Keeping in Touch day has been used. However, Services Australia must be informed if: • more than 10 Keeping in Touch days are accessed before the end of the Paid Parental Leave period • if a Keeping in Touch day is accessed within the first two weeks of birth or adoption, or • if normal work is resumed other than what is allowable as a Keeping in Touch day. c) Income test The income test applies to the primary carer and is based on adjusted taxable income. Income of the claimant’s partner is not assessed. The income limit is $150,000 per annum for 2020/21. Income must be below this level to be eligible for the scheme. The relevant year is not the current financial year, but the

“reference year”. Generally, details of income will need to be provided, as reported to the ATO for the reference year, plus any additional information required supporting the additional components of ATI. Adjusted taxable income includes: • taxable income • foreign income and tax exempt foreign income • total net investment loss • reportable fringe benefits • reportable superannuation contributions • certain tax-free pensions or benefits, and • super income stream benefits. less deductible child maintenance expenditure. Residency test The residency test generally requires that the person be: • an Australian citizen • permanent visa holder • a Special Category Visa holder residing in Australia, and • certain temporary visa holders. The residency test continues to be applied on a daily basis to allow the person to remain eligible for the parental leave payment. A waiting period of two years applies to residence visa holders or specified subclass visa holders that were granted after 1 July 2019. Payments of parental leave Effectively, the paid parental leave is funded by the government, however, the actual payment to a primary carer will be via the employer in most cases, provided that, among other conditions, the person has worked for the employer for at least 12 months before the birth or adoption and will stay with the same employer until the end of the leave period. If the employer cannot make the payment for an acceptable reason, Services Australia will make the payment. If an employer is making the payments, the government directs the payment to employer. This applies to the 12 week leave period and any flexible days takes as continuous leave. Flexible leave days taken other than in a continuous manner will be paid via Services Australia. Paid parental leave is paid in instalments. The frequency of payments will depend on who is making the payment (ie Services Australia or employer). If the employer is making the payments, the frequency will be the same as the regular pay period. If payable by the government, it is paid fortnightly. Employers are not required to pay Superannuation Guarantee on paid parental leave payments. Dad and partner pay This provides a government funded payment of two weeks at the minimum federal wage to fathers and eligible partners caring for a natural or adopted child. Eligibility is similar to the paid parental leave including residency, work test, and individual adjusted income of up to $150,000 pa.

The payment is available when the partner is on unpaid leave or is not working. The payment is taxable and may affect entitlement to other payments. It is paid directly by Services Australia. Newborn supplement and Newborn Upfront Payment Those that are not eligible for paid parental leave may be eligible for the newborn payments. The upfront payment is a single tax free lump sum of $570 per child to assist with the upfront costs of a newborn baby. The Newborn Supplement is a tax-free payment paid for up to 13 weeks. The maximum payment from 1 July 2020 is $1,709.89 over 13 weeks for the first child, with an additional $570.57 for subsequent children. If eligible for the maximum rate of FTB A, the maximum rate of Newborn Supplement is payable, and entitlement to the supplement reduced where eligibility for FTB A is reduced. (¶13-715). Eligibility for both the upfront payment and the supplement are assessed as part of the FTB claim and a separate application is not required.

¶13-710 Family Tax Benefits The family tax benefit is paid in two parts — Family Tax Benefit Part A (FTB A: ¶13-715) and Family Tax Benefit Part B (FTB B: ¶13-720). Both payments are subject to an income test but no assets test. A person (adult) may be eligible for Family Tax Benefit (A and/or B) if they are an Australian resident and providing care to a child who is: • up to 15 years of age • aged 16–19 years and in full-time secondary study (or are exempt from this requirement). The child must also: • be in the adult’s care and the adult is legally responsible for the day-to-day care, welfare and development of the child for at least 35% of the time • not be receiving a pension, benefit such as Youth Allowance (which includes a pension or benefit received by someone of the child’s behalf). From September 2019, family tax benefit was also extended to ABSTUDY recipients aged 16 and over who study away from home.

Note A family is eligible for FTB A until the end of the calendar year for a child who turns 19, provided they are also a full-time secondary school student. Although both members of a couple may be eligible for a payment of FTB, only one person is eligible at a time to receive FTB in respect of a particular child.

¶13-715 Family Tax Benefit Part A FTB A is payable to families with FTB child (as defined above). It can be paid to a parent, guardian or an approved care organisation. The FTB A payment rates (as at 1 July 2020) are listed in the table below. Base rate (per fortnight) Each child

$60.90

Maximum rate (per fortnight, excluding supplements) Each child aged under 13 years

$189.56

Each child aged 13–15 years

$246.54

Each child aged 16–19 years, secondary student or exempt from requirement

$246.54

Each child in an approved care organisation aged 0–19 years

$60.90

FTB A is income tested based on adjusted taxable income (defined at ¶13-725). Parents with an entitlement to an income support payment automatically qualify without having to provide income estimates. If the income levels (as at 1 July 2020) in the following table are exceeded, only the base rate of FTB A is payable. Number of children aged 0– 12 years

Number of children aged 13–15 years or secondary students aged 16–19 years Nil

Nil

One

Two

Three

$79,826

N/A

N/A

One

$72,398

$96,598

N/A

N/A

Two

$89,170

N/A

N/A

N/A

Three

N/A

N/A

N/A

N/A

Income limits are higher if eligible for Rent Assistance or the Energy Supplement. N/A indicates base rate does not usually apply for this household combination because the rate under the first test is usually higher.

The following table shows the income levels at which FTB A is no longer payable (as at 1 July 2020). Number of children aged 0– 12 years

Number of children aged 13–15 years or secondary students aged 16–19 years Nil

Nil

One

Two

Three

$104,281

$112,931

$134,357

One

$104,281

$109,573

$129,405

$150,831

Two

$109,573

$124,453

$145,879

$167,304

Three

$119,501

$140,927

$162,352

$183,778

These amounts may be higher if eligible for Rent Assistance or the Energy Supplement.

Services Australia encourages families to contact them for an accurate assessment based on individual circumstances. Maintenance income test The receipt of child maintenance payments is included in the calculation of the income test. Further, where an individual has child maintenance expenditure in a year, this amount is deducted from their income when calculating FTB entitlement. The following table shows the level of maintenance income which can be received before FTB A is impacted. Date

Single parent, or one of a couple receiving

Couple, each receiving maintenance

For each additional child

maintenance 1 July 2019

$1,686.30

$3,372.60

$562.10

The maximum FTB A reduces by 50 cents for each dollar of child maintenance received above these thresholds. Maintenance payments can only reduce FTB A to the minimum amount. It is possible to accrue “Maintenance Income Credits” where the full Maintenance Income Free area is not used in a particular year. Unused credits can be carried forward to future years, to offset arrears of child support received in a future financial year. Family Tax Benefit Part A Supplement The maximum rate of FTB A supplement is $781.10 for each child and paid after the end of the financial year once a person’s entitlement has been reconciled. The amount of supplement payable will be calculated based on how many children the applicant had in their care, and how many days in the year the person was eligible for FTB A. To be eligible: • the person and/or partner must lodge their tax returns or notify the Department of an exemption from lodging a return • have an adjusted taxable income (include partner’s income) of no more than $80,000 • during the financial year a child turns four, the child must meet the health check requirements and the person/partner receives an income support payment. Newborn Supplement and Newborn Upfront Payment An additional payment to the FTB A is available for those families not receiving paid parental leave to assist with upfront costs of a newborn child. This is an increase to the FTB A rate for up to 13 weeks. The Newborn Supplement is payable for an FTB child who is: • less than one year of age and in the care of a parent • less than one year of age and entrusted to the care of a non-parent for a continuous period of at least 13 weeks, or • any age and placed for adoption and eligibility for FTB A for the adopting parent (or partner) occurs within 12 months from the day of the child’s adoption. Eligible families receiving the Newborn Supplement also receive the Newborn Upfront Payment. The additional FTB A payment from the Newborn Supplement and Newborn Upfront Payment is $1,709.89 for the first child and $570.57 for second and subsequent children. An initial Newborn Upfront Payment of $570 is made and the balance paid as part of the fortnightly payments over a 13-week period. Health Care Card The Health Care Card is available where family income does not exceed the FTB A income free area. Where care of a child is shared, both individuals may qualify automatically if their income is below this limit. This applies for children up to age 15 and children aged 16–19 in secondary study (or exempt from study). The card is issued every 12 months.

¶13-720 Family Tax Benefit Part B Family Tax Benefit Part B (FTB B) provides an additional payment to single income families (with a dependent child under 13) and sole parents who have a dependent child. A member of a couple is eligible for FTB B if that person cares for a dependent child under 13 for at least 35% of the time. Single parents, grandparents or great grandparents may be eligible for FTB B if caring for a child at least 35% of the time and the child is:

• under 16 year of age, or • a full time secondary student and is payable until the end of the calendar year in which the child turns 18. The rates of FTB B are: FTB B payment rates (current as at 1 July 2020)

Maximum rate (per fortnight) excluding supplements

Under five years

$161.14

5–15 years (or 16–18 for full-time student)

$112.56

Eligibility for FTB B is limited to families where the higher income earner in a couple or the sole parent has adjusted taxable income of $100,000 per annum or less. Sole parents automatically receive the maximum amount of FTB B — if their income is $100,000 per annum or less. For two parent families, if the primary income earner earns income of $100,000 per annum or more, FTB B is not payable. If the primary income earner’s income is less than $100,000, the amount payable depends on the income of the lower earner. For details of the income test refer to ¶13-725. The lower income earner can earn up to $5,767 pa and receive the maximum FTB B. FTB B is reduced by 20 cents for each dollar earned over $5,767 pa. A two parent family will qualify for some FTB B if: • the youngest child is under age five and the lower income earner’s income is less than $28,761 pa, or • the youngest child is aged between five and 18 years and the lower income earner’s income is less than $22,338 pa.

¶13-725 Income test for Family Tax Benefits The income test for Family Tax Benefits (A & B) is based on a family adjusted taxable income which is: • taxable income (assessable income less tax deductions) plus • the value of adjusted fringe benefits • reportable superannuation contributions (eg salary sacrifice amounts to superannuation, personal deductible superannuation contributions) • any target foreign income • any net investment loss • any tax-free Centrelink pensions and benefits less • 100% of any child support paid by the client.

Note The taxable portion of superannuation lump sums is included in taxable income and will increase

income for family tax benefit purposes. Care should be taken to determine the impact of receiving such payments. If a person is overpaid Family Tax Benefit, they may need to repay this amount.

To receive FTB as payments throughout the financial year, an estimate of income must be provided. This is not required if the person or their partner receives a means tested payment from Centrelink or Veterans’ Affairs. If payments are based on estimated income, the entitlement is reconciled when the tax return is lodged after the end of the financial year. If a person has been underpaid, a top-up payment is made. If an overpayment has occurred (as income was underestimated), a debt arises which must be repaid. No reconciliation applies to any part of the year during which the person is receiving income support as the full amount is payable for this period. Families have 12 months from the end of the financial year to reconcile their income and claim a lump sum.

¶13-730 Child Care Subsidy The Child Care Subsidy (CCS) payment replaced the Child Care Benefit and the Child Care Rebate on 2 July 2018. The Additional Child Care Subsidy (ACCC) may also be payable to eligible recipients. Eligibility for the CCS is determined by: • applying an income test to determine the maximum percentage of subsidy payable, then • applying the maximum percentage of subsidy available to the lower of – the actual hourly rate charged for care, or – the government’s maximum capped hourly rate for the type of care provided, then • calculating the maximum “subsidy hours” available per fortnight, based on an activity test. Immunisation and residency requirements also apply. The subsidy is paid directly to the care facility, and is effectively passed on as a reduction in fees. That is, families will pay the difference between the subsidy to which they are entitled, and the actual cost of care. Care provers must be approved by the government to get the CCS. Eligible providers may include: • centre based day care • family day care • before and after school care and vacation care, and • in home care (which requires an accepted qualification as an accepted in home care educator, and does not apply where extended family simply takes care of a child). An annual cap ($10,560 as at 1 July 2020) applies to limit to maximum annual subsidy payable (per child, per financial year) where family income exceeds $186,958. There is no annual cap where income is $189,390 or less. The ACCC may be payable in circumstances where the child is in the care of grandparents, where families are experiencing significant financial hardship, or where a family is “transitioning to work” from income support payments. Calculating the CCS There are generally four steps to determining the CCS payable in respect of a child. Step 1: Apply Income test to determine maximum percentage of subsidy payable

The maximum subsidy will apply where family income is less than or equal to $69,390. Entitlement will cut out when family income reaches $353,680. These income thresholds apply for 2020/21 and are indexed annually to CPI. Family income

CCS percentage

Up to $69,390

85%

More than $69,390 to below $174,390

Decreasing to 50%*

$174,390 to below $253,680

50%

$253,680 to below $343,680

Decreasing to 20%*

$343,680 to below $353,680

20%

$353,680 or more

0%

*Entitlement decreases by 1% for each $3,000 of family income above the lower threshold

Note It may be possible to claim the subsidy even where the family income estimate exceeds the cut-out threshold. If income is below the estimated amount, any entitlement is paid at the end of the year when payments are balanced. Step 2: Determine hourly rate cap based on type of care and actual cost The government has prescribed maximum hourly rates of CCS based on the type of service. Type of service

Maximum hourly rate cap — children below school age

Maximum hourly rate cap — school age children

Centre based day care (long day care and occasional)

$12.20

$10.67

Outside school hours care (before, after and vacation care)

$12.20

$10.67

In home care (per family)

$33.17

Family day care

$11.30

To determine the maximum CCS entitlement, the maximum subsidy percentage from Step 1 is applied to the lower of the: • maximum hourly rate cap based on type of care (see above), and • actual hourly cost of care Where a flat daily fee is charged by the service provider, the daily fee is divided by the facilities total hours of operation to determine the hourly rate. This is regardless of the actual number of hours each day that a child has received care. Step 3: Apply Activity test to determine maximum subsidy hours actually available per fortnight The maximum number of hours for which the subsidy is payable will is determined by an activity test. The number of subsidised hours increases with higher levels of activity, to a maximum of 100 subsidised hours per fortnight. A minimum of eight hours of acceptable activity needs to be performed to be eligible for the CCS. Activity (hours per fortnight)

Maximum number of subsidised hours (per fortnight)

Less than 8 (income ≤ $69,390)

24

Less than 8 (income ≥ $69,390)

0

8–16

36

17–48

72

49 or over

100

Note: Low income families are able to claim up to 24 subsidised hours without having to meet an activity test. Temporary COVID-19 changes In response to the COVID-19 pandemic, families who are impacted may be eligible for up to 100 subsidised hours of child care per fortnight. At the time of publication, this support measure was in place from 13 July to 4 October 2020. This measure applies where eligible CCS recipients are working reduced hours as a result of the pandemic. It does not apply where a person has voluntarily chosen to reduce hours for other reasons. Other eligibility rules apply, including: • a requirement that an eligible person was completing more than 16 hours of recognised activity per fortnight, and • the person continues to do at least eight hours of recognised activity per fortnight. Example Lucy (4) attends a child care facility. Her mother Cherie is a single parent. She works 60 hours per fortnight, and earns $55,600 pa. Lucy attends centre based day care and Cherie pays a flat fee of $105 per day. The centre operates for 10 hours per day. To determine Cherie’s eligibility for CCS on behalf of Lucy the follow steps should be followed: Step 1: Apply Income test to determine maximum percentage of subsidy payable Because Cherie’s income is less than $69,390, the applicable subsidy percentage is 85%. Step 2: Determine hourly rate cap based on type of care and actual cost Because Cherie is charge a flat daily rate, the hourly rate is determined by dividing the daily rate by the facility’s hours of daily operation. This is regardless of how many hours per day that Lucy attends the facility. $105/10 hours = $10.50 per hour The maximum subsidy percentage calculated in Step 1 is applied to the lesser of: • the maximum government rate for the type of care provided ($12.20), and • the actual hourly cost of care ($10.50). Therefore the hourly rate cap is 85% x $10.50 = $8.93 per hour. Cherie’s out of pocket expenses per hour are equal to the difference ($1.57 per hour). Step 3: Apply Activity test to determine maximum subsidy hours actually available per fortnight Cherie works 60 hours per fortnight. Therefore the maximum number of hours per fortnight for which she will be eligible to receive a subsidy for Lucy’s care will be 100.

¶13-735 Grandparent child care subsidy The Child Care Subsidy Grandparent is designed help grandparents who have the primary responsibility for raising and caring for their grandchildren. It covers up to 100 hours of subsidised care. Like CCS, it is paid directly to the child care provider. To be eligible for the subsidy, a grandparent carer must be: • eligible for CCS • receiving an income support payment from Centrelink or the Department of Veterans’ Affairs • be the grandparent or great grandparent of the child

• have at least 65% of the care of the child, and • be the main decision maker in relation to the child’s care, welfare and development.

¶13-740 Parenting payment Parenting payment is an income support payment for single or partnered parents. If paid to a partnered parent, it is only payable to one member of the couple. To qualify for the parenting payment the person must have: • a qualifying child under the age of six if partnered or under age eight if single • agree to a job plan if there are mutual obligation requirements (ie activities required to be undertaken which increase chances of obtaining employment) • be an Australian resident or satisfy the residency period or arrived as refugee or have qualifying residency exemption. Parenting payment is a means tested payment. It is subject to the allowance assets test rules, and an income test also applies.

¶13-745 Youth Allowance Income support is also available for students in some cases through Youth Allowance. It is payable to eligible: • full-time students 18–24 years of age • Australian apprentices aged 16-24 • unemployed people 16–21 years old who are either actively seeking suitable paid work, combining part-time study with job search, undertaking an approved activity or temporarily incapacitated for work or study • children aged 16 or 17 who are independent or need to live somewhere other than with their family to study, or • full time students aged 16 or 17 who have completed year 12 or equivalent. Eligibility Depending on whether the person is partnered, dependent or independent, eligibility for Youth Allowance may be determined based on satisfying: • an activity test (generally that is undertaking full time study, meeting job search requirement) • personal + partner income test and personal asset test (if recipient is independent) • parental income test (if recipient is dependent). The liquid assets waiting period (¶6-720) and income maintenance period (¶6-730) both apply to determine how long before payments start. Unless the child is independent, payments for a child under age 18 are made to their parents. The parents can give permission for the payment to be received by the child. Dependent individuals undertaking full-time secondary study cannot apply for Youth Allowance until turning 18 unless the individuals: • become independent

• are required to live away from home to study, or • are determined by the department to not benefit from the FTB that is being paid to the individuals’ parents.

CHILD SUPPORT ¶13-800 Child support or child maintenance In the event of family breakdown, both parents are still responsible for the children of the relationship. When a relationship breaks down, child support may be payable by one person. There are a number of options in relation to child support. The type of arrangement that is most appropriate will depend on individual circumstances, including the willingness of each party to negotiate terms privately. It is important to note that there is no requirement for the non-custodial parent to have been in a relationship to be liable to pay child support. Broadly, there are three options in relation to child support: • Child Support Agreement – Binding Agreement – Limited Agreement • Child Support Assessment, and • Child Support ordered by the court

Tip In the event of family breakdown, it is recommended that each party seeks independent legal advice. The following section provides only an overview of some issues on child support. Further details can be found at www.servicesaustralia.gov.au/individuals/subjects/your-child-support-options. Special rules apply to children in WA whose parents were never married (“ex-nuptial children”). Further details on Family Breakdowns are covered in Chapter 18.

¶13-805 Child Support Scheme The child support scheme was established as a mechanism to assist individuals who had ceased to be in a relationship, to take financial responsibility for their children. Administration of the scheme is the responsibility of the Services Australia. The provision of alternatives to court ordered maintenance recognises the limitations of the court process in terms of the associated costs and time. Child Support Agreements A child support agreement may be appropriate where a mutual agreement can be reached as to how much child support one party should provide to the other. The agreement can be registered with Services Australia. A child support agreement can be “binding” or “limited”. A binding agreement allows individuals to determine privately the amount of support that will be paid. The amount agreed can be any amount and there is no requirement that it aligns with what would have been assessed by Services Australia as being payable based on their formula. To implement a binding

agreement, a signed legal certificate is required to confirm that legal advice was sought before agreeing to the terms. To alter or revoke a binding agreement, a new agreement may need to be entered into. Where parties cannot agree, an application may need to be made to the Family Court, depending on the circumstances. An agreement may simply cease however if for example, a person ceases to be an eligible carer for the child. If a lump sum payment is agreed to, parties will need to have a “child support assessment” (see below) completed by Services Australia. This is not required in the case of regular payments. In the case of a lump sum, the amount agreed must be at least equal to the annual rate calculated under the assessment. If more than the annual requirement is paid, Services Australia will credit ongoing annual rates against the lump sum initially, until it runs out (at which point, additional payments will need to be made). A limited agreement could alternatively be implemented, however the amount of support payable in this case must be at least equal to an amount calculated by Services Australia (see below). Unlike a binding agreement, a limited agreement may be cancelled by either party after 3 years. It could also be terminated earlier if both parties agree in writing to end or establish a new agreement, or where a court sets aside the agreement. Legal advice is not required before entering into a limited agreement. Child Support Assessments If this option is preferred, Services Australia will calculate the level of support required based on income, and the amount of time a child is in a person’s care. Periodic reassessments mean that the level of support will be adjusted regularly. Child support is calculated by using a basic “8 step” formula. The formula includes: • each parent’s income • the number of children • the living arrangements (eg who has custody of the children for the majority of the time). The formula takes into account issues such as: • the cost of caring for children (including at different ages) • both parents’ income, and • recognition of shared care arrangements. More information about this formula can be found on the Services Australia website: www.servicesaustralia.gov.au Income for child support assessments An individual’s income for the purpose of the 8 step formula is assessed as follows: Taxable income Plus Reportable superannuation contributions Plus Reportable fringe benefits Plus Target foreign income Plus Certain social security tax-free pensions or benefits received by the parent Plus Total net investment loss

Less Self-support payment = Adjusted income where: Taxable income is taxable income under ordinary terms and derived from the person’s last tax return. It relates to the child support period that the child support assessment applies. Self-support amount is the same for both parents, and is calculated as: • 1/3 x Annualised Male Total Average Weekly Earnings for the relevant June quarter. The above levels of income are generally determined by reference to the “last relevant year of income” (the previous financial year). An amended amount is only accepted in limited circumstances. Once the income of both parents has been determined, the costs of the children will be determined by the parents’ combined income for child support purposes. The costs are divided between the parents according to each parent’s share of the income. Child Support ordered by the court In some circumstances, including where a child is not covered by child support legislation, the Family Court or the Federal Circuit Court may instead make an order for child maintenance payments. This may apply for example in the case of a disabled child over the age of 18, or in respect of step-parents. Child support and impact on Family Tax Benefit In relation to FTB Part A, a person may be required to have taken “reasonable action” if they are entitled to apply for maintenance in order to receive more than the base pate of FTB Part A. This is known as the “maintenance action test”. This can also impact entitlement to Rent Allowance and the rate payable. Exemptions from the maintenance action test may apply in certain circumstances. The assessment of income received from maintenance is generally based on a “notional assessment” of maintenance income received, rather than the actual maintenance which has been paid. A different applies to payments received in arrears, or where a significant change in circumstances has occurred where a binding agreement is in place, and the agreement remains in force.

¶13-810 Child maintenance trusts A child maintenance trust is a trust specifically established to provide for the financial support of a child. A correctly established child maintenance trust will enable income paid from the trust to a minor to be taxed at adult tax rates and not penalty rates. Actual capital or property must be transferred into the trust. The income derived from the trust must be used towards the benefit of the child. For example, the trust cannot be used to run a business. Taxation Ruling TR 98/4 provides details on when income from a child maintenance trust is treated as excepted income. The amount of capital directed to the trust must be sufficient to allow the non-custodial parent to meet their child maintenance requirements. Consideration must be given to the cost of transferring assets into a child maintenance trust such as capital gain tax (there is no rollover relief) and stamp duty. A child maintenance trust can be agreed to be established between the child’s parents. This can be by consent or court order. An assessment, usually by Services Australia, is undertaken to determine the level of support required to be paid by the non-custodial parent. A child maintenance trust is an option where a person has available assets to transfer. This may be appropriate for self-employed individuals or other individuals who may be exposed to certain financial risks in the future. Establishing a child maintenance trust ensures that the child will be provided for in the future regardless of the non-custodial parent’s financial situation. It also effectively allows the paying parent to pay their child support obligations from pre-tax earnings.

ESTATE PLANNING ¶13-900 Estate planning for children Death of one or both parents can create major upheavals for a child. Often new or young parents do not proactively consider making the appropriate arrangements to ensure that in the event of their premature death, the child (or a guardian on their behalf) will have adequate financial and emotional resources required. It is not uncommon for parents to simply assume that in the event of their demise, a particular family member or friend would step in and raise the children. However, these arrangements are frequently not formalised through the execution of any legal documentation. Further to this, if a young family has not accumulated sufficient financial resources for a guardian to raise the child, consideration may be given to establishing a life insurance policy to provide the required funds. As premature death is generally unplanned and sudden, it is essential that parents have a valid will and make appropriate provisions for children at the earliest point possible. Intestacy If a person dies without a will, their assets are divided according to the statutory formula for that state or territory. Particularly in the case of blended families or where a person has children from a previous marriage, dying intestate may not provide adequate levels of financial support to certain dependants in the proportions that are best for the family or otherwise desirable. Family provision legislation State and territory legislation ensures that dependants are provided for in the event of a person’s death. This includes a spouse, children and other financial dependants. The courts can alter the terms of a will if the deceased failed to make adequate provision for certain dependants and they lodge a contest of the will. The estate may be required to cover court costs for any contest that reduces the overall estate and impacts all beneficiaries.

¶13-905 Nominating a guardian One key issue for parents is the nomination of a guardian as a safeguard in case both parents die before the children reach age 18. The guardian is responsible for “life decisions”. The guardian must ensure that housing, clothing and education are provided for the child. When selecting a guardian, issues to consider include the following: • Is that person willing to take on that role? • Does that person have similar views on issues relating to child raising? • Is the person able to bring up the child in accordance with the parent’s wishes? • Where the child will live? • Financial arrangements to ensure the guardian can provide for the child. The appointment of a guardian may avoid disputes between family members; however, the court does have the ability to override the nomination of a guardian. In some cases the guardian will also be the trustee of assets held on behalf of the child. It may, however, be more appropriate in some cases to have another person act as trustee instead of the guardian. Care should be taken if nominating different individuals as conflicts may arise over differences in the views on the child’s needs. Guardianship provisions should be reviewed if and when circumstances change. A person who is considered to be an appropriate guardian for a child, should both parents die today, may not necessarily

be a suitable candidate in years to come (for example, if the person falls ill, passes away, relocates, or has had a shift in priorities).

¶13-910 Financial provisions Providing financially for a child is a crucial consideration for parents. This may be from existing assets; however, in most cases, there will be a need for life insurance (¶7-000). A person who has dependants, which may include a spouse and children, should review insurances to ensure these are adequate taking into account the change in circumstances. Levels of required insurance change throughout the various family life stages and should be regularly reviewed. For example, the level of insurance may need to increase to allow for: • increased debt • additional children • funding income shortfall due to loss of income • capital expenditures (including education expenses) • provide legacies for children. Some life insurance policies also include optional cover to pay a lump sum if the child contracts one of a specified list of illnesses. A serious child illness can be just as devastating on a family’s finances and wellbeing as that of a parent. This type of cover provides money to pay for medical treatment or to allow a parent to give up work to care for the child. It is usually offered at a small additional premium.

¶13-915 Testamentary trusts A testamentary trust is a trust established after the death of a person. Provision must be made in the deceased’s will to allow the trust to be established. The will can specify that a testamentary trust must be established or allow the executor to decide if it is in the interest of the dependants based on the circumstances at that time. Testamentary trusts are a useful estate planning tool particularly where young children are involved as it can help to minimise the tax for the surviving parent or provide management of a child’s inheritance. As different children may have different needs, it may be worth establishing more than one testamentary trust, rather than having children and other dependants as beneficiaries of the same trust. Children with special needs may be better protected over the long term by using a testamentary trust, rather than simply until they are no longer considered minors. This may include cases where a child is: • disabled • a spendthrift, or • drug dependent. If a testamentary trust is to be established, consideration must be given in the will to: • who is the appointer • who is the trustee(s) • who are beneficiaries • specific rules for the trust (eg investment restrictions, payment of capital to beneficiaries, etc) • winding up the trust

• distributions of income and capital. The advantages of using a testamentary trust include: • asset protection • flexibility for the distribution of income and capital (if discretionary) • tax planning as income received by a child from assets directly from the deceased estate will be taxed at adult tax rates • asset protection • can restrict access until the child reaches a specified age. Disadvantages of a testamentary trust include: • the trustee has full discretion and some beneficiaries may not be provided for in accordance with the deceased’s wishes if the trustee favours one beneficiary over another • loss of control by the beneficiary until the trustee makes a distribution • cost of transferring assets to a beneficiary upon absolute entitlement. Testamentary trusts and estate planning are discussed further at ¶19-000.

REDUNDANCY, EARLY RETIREMENT AND INVALIDITY The big picture

¶14-000

Termination of employment Termination of employment

¶14-100

Overview of concessional tax treatment for termination payments

¶14-110

Planning checklist for redundancy

¶14-120

Genuine redundancy and early retirement scheme Definition of genuine redundancy

¶14-200

Definition of early retirement scheme

¶14-210

Payments that receive concessional tax treatment

¶14-220

Unused annual leave

¶14-230

Unused long service leave

¶14-240

Employer payments

¶14-250

Calculating the tax-free redundancy payment

¶14-260

Invalidity Definition of invalidity

¶14-300

Unused annual and long service leave

¶14-310

Calculation of invalidity segment of a life benefit termination payment ¶14-320 Calculation of disability benefit of a superannuation lump sum

¶14-330

Other issues regarding termination payments Superannuation contribution caps

¶14-425

Social security

¶14-430

Invalidity segment — whether to receive as a lump sum or pension

¶14-440

Investing payout versus paying off debt

¶14-450

¶14-000 Redundancy, early retirement and invalidity

The big picture This chapter examines a range of financial issues that should be considered when employment is terminated due to a genuine redundancy, early retirement or invalidity. Genuine redundancy and early retirement scheme • Specified criteria must be met for the employment termination to be classified as a genuine redundancy or early retirement scheme (¶14-200). • A portion of the employer’s termination payment is received tax-free depending on the length of

service with the employer. • Payments for unused annual leave and long service leave paid are not life benefit termination payments, but are concessionally taxed (¶14-230, ¶14-240). Invalidity • If employment is terminated due to invalidity, the components can be recalculated to include an invalidity segment. This forms part of the tax-free component and is received tax-free (¶14-320). An invalidity amount can be calculated for employees and self-employed persons who satisfy the criteria (¶14-300). Other considerations A person receiving a redundancy package also needs to consider the impact of the following: • Life benefit termination payments can only be received in cash (¶14-250). • The ability to contribute to superannuation within the contribution caps (¶4-220 to ¶4-250). All new contributions are preserved and a condition of release must be satisfied to allow access (¶4-400). • Social security. Termination payments may result in a lengthy period before the person can receive income support payments, due to the income maintenance period (IMP) and the liquid assets waiting period (LAWP) (¶14-430).

TERMINATION OF EMPLOYMENT ¶14-100 Termination of employment Unforeseen termination of employment can have serious effects for clients, both in the short term (paying living costs) and long term (funding retirement). It is important to understand the options available for any money received as part of a termination to ensure maximum use is made of concessions and to make the funds last as long as possible. In developing a financial strategy for a termination of employment, there are a number of issues that need to be considered, including: • whether to invest termination payment or pay off debts • eligibility for social security and the impact of termination payments, in particular waiting periods (if applicable) • timing strategies to manage taxation on termination payments, and • ability to contribute to superannuation and requirement for access to capital. Termination of employment may also involve a change in lifestyle, therefore issues surrounding lifestyle planning also require consideration. In many cases, the person may effectively be retiring, but will have a longer than planned retirement period and a shortened saving period. The checklist in ¶14-120 is a good starting point to work through the relevant financial issues. The main points are to ensure payments are received most tax-effectively and income is replaced. This is also a good time to review insurances. If cover had been provided within the superannuation fund or by the employer, this cover may terminate. The client should investigate the ability to accept continuation cover in these cases, if available, and how to continue funding premiums (either utilising the client’s existing account balance, particularly in the short term, or ability to make contributions).

¶14-110 Overview of concessional tax treatment for termination payments If employment is prematurely terminated due to organisational restructure or ill health, tax concessions may apply to some payments made by the employer. These concessions may be available where employment is terminated through: • genuine redundancy (¶14-200) • early retirement scheme (¶14-210), or • invalidity (¶14-300). These situations are distinguished from a normal retirement or resignation. Because these situations imply premature termination of employment, employment must be terminated before the employee reaches normal retirement age. This is usually before age 65. However, some employment awards or terms may set an earlier retirement age or specify that retirement must occur after a period of service/employment has been served. If employment is terminated after retirement age, concessional taxation treatment will not apply. The taxation rules for a normal retirement or resignation apply.

¶14-120 Planning checklist for redundancy The following is a quick checklist for planners to follow.

Checklist Step 1

If it is a voluntary payment, check whether the client can afford to accept the package financially and in terms of lifestyle.

Step 2

Identify all payments the person is entitled to receive and divide into: (a) amounts that can form a life benefit termination payment, and (b) amounts that cannot form a life benefit termination payment.

Step 3

Calculate the tax-free portion.

Step 4

Calculate the life benefit termination payment (Step 2(a) minus amount at Step 3).

Step 5

Identify other amounts that will automatically be paid in cash: (a) unused annual leave and leave loading (b) unused long service leave (c) salary/wages.

Step 6

Decide how to use the cash payments, eg pay off debts, invest, contribute to super.

Step 7

Consider eligibility for social security and the impact of waiting periods, if applicable.

This checklist may be modified if the client is terminating employment due to invalidity. Invalidity is discussed in ¶14-300. In invalidity situations, the tax-free portion (ie invalidity segment) is calculated as a percentage of the life benefit termination payment (¶14-320).

GENUINE REDUNDANCY AND EARLY RETIREMENT SCHEME

¶14-200 Definition of genuine redundancy The issues and taxation implications for a genuine redundancy and early retirement scheme are similar. The only difference is the conditions under which the payment is made. A genuine redundancy may be offered by an employer if a particular position/job is no longer required and, as a result, the employment of the person filling that position is terminated. The termination of employment should not arise because of issues specific to the individual employee. It results because the job they are currently doing is no longer required. The termination must have been initiated by the employer. If a person volunteers to accept a termination package offered by the employer, provided the ultimate decision to terminate remains with the employer, it can still be classified as a genuine redundancy. A redundancy is genuine if the employer places the employee in a position where they have little option but to resign. For example, a company decides to centralise, closing its offices in Perth to move all staff to Sydney. The company offers the staff in Perth the opportunity to relocate or to accept a genuine redundancy. While formal approval to qualify for a genuine redundancy does not need to be sought from the Australian Taxation Office (ATO), the conditions specified in taxation legislation (Income Tax Assessment Act 1997 (ITAA97) s 83-C) must be satisfied.

¶14-210 Definition of early retirement scheme The issues and taxation implications for a genuine redundancy and early retirement scheme are similar. The only difference is the conditions under which the payment is made. A program put in place by an employer may qualify as an early retirement scheme if the following conditions are met: • the scheme is offered to all employees in a class identified by the employer. For example, this class/group could be defined as all employees, or could be all employees in a particular age group, occupational skill group, or other class approved by the Commissioner of Taxation • the scheme is entered into with a view to rationalising or reorganising the employer’s operations with specific objectives, and • the Commissioner has formally approved the scheme as an early retirement scheme prior to its implementation (ITAA97 s 83-180). This is supported by the ATO issuing a Class Ruling specific to that scheme.

¶14-220 Payments that receive concessional tax treatment In the event of a genuine redundancy or early retirement scheme, the amounts that are potentially eligible for concessional taxation treatment are as follows: • payments for unused annual leave and unused long service leave, and • any employment termination amounts, including unused sick leave, that exceed the amount payable if the person merely retired or resigned. This amount is generally called the redundancy payment, but may also be referred to as a golden handshake, ex-gratia payment or retrenchment package. The tax legislation outlines specific criteria that must be satisfied for the concessional tax treatment to apply (ITAA97 s 83-175 genuine redundancy and s 83-180 early retirement). These criteria are as follows: • the employee is dismissed before the earlier of the following: – the day the person reached Age Pension age*, or – if the employee’s employment would have been terminated when he or she reached a particular

age or completed a particular period of service — the day he or she would reach the age or complete the period of service (as the case may be) • the payment is not from a superannuation fund, ie it must be paid by the employer • where the employment arrangement is not at arm’s length, the employer payment must not exceed the amount that could reasonably have been expected to be paid under an arm’s length arrangement • at the time of termination, there must not be any agreement between the employer and employee, or between the employer and another person, to employ the person after that time. * Age Pension age depends on the person’s date of birth and is gradually increasing to age 67 (¶6-140). If employment is terminated due to a genuine redundancy or early retirement scheme, it is important to identify the break-up of payments received and then determine the taxation treatment. In many cases, the payments are included in the client’s assessable income which may impact eligibility for other government benefits or concessions, or liability for levies that are based on assessable or taxable income assessments (eg low income tax offset, Family Tax Benefit).

¶14-230 Unused annual leave Upon termination of employment, employees receive payment for unused annual leave. If employment is terminated due to genuine redundancy, early retirement scheme or invalidity, it may receive concessional taxation treatment. In these circumstances, payments for unused annual leave are included in assessable income for the year received. Payments for unused annual leave are included on the Pay As You Go (PAYG) payment summary given to the employee and PAYG tax must be deducted by the employer at the rate of 30% plus Medicare. If the person’s marginal tax rate is greater than 30%, a tax offset is applied so the whole amount is taxed at a maximum rate of 30% plus Medicare. If the marginal tax rate is lower, the actual marginal tax rate will apply and any excess tax deducted by the employer can be used to offset other tax liabilities or be refunded in cash. Unused annual leave payments received due to genuine redundancy, approved early retirement or invalidity may be taxed more favourably compared to receipt on resignation or retirement. The table below summarises the tax treatment of unused annual leave payments. Resignation or retirement

Genuine redundancy, invalidity, early retirement*

Leave accrued before 18 August 1993

100% taxed at maximum rate of 30% + Medicare

100% taxed at maximum rate of 30% + Medicare

Leave accrued after 18 August 1993

100% taxed at marginal tax rate + Medicare

100% taxed at maximum rate of 30% + Medicare

* ITAA97 s 83-85. Example Doug’s employment is terminated on 30 June 2021 due to a genuine redundancy. He receives a gross lump sum payment for unused annual leave of $15,000. Tax of $4,800 [ie $15,000 × 32%] is deducted by Doug’s employer. His other taxable income for the financial year is $95,000 after salary sacrificing $12,000 into superannuation. The unused leave payment is added to his taxable income which would see it taxed at his marginal rate of 37% plus Medicare, generating a tax liability of $5,850 on this payment. However, a tax offset is automatically applied by the ATO of $1,050 ($5,850 − $4,800) so the tax is limited to 30% plus Medicare. Assume Doug’s redundancy is deferred until 1 July 2021 and in this financial year he earns no other income except the $15,000 unused annual leave payment. This amount is taxable income and incurs a tax liability of nil (as $15,000 is less than the tax-free threshold). His employer is still required to withhold tax of $4,800 so he is entitled to a refund of this amount when his 2021/22 tax

return is completed.

¶14-240 Unused long service leave Upon termination of employment, an employee may receive payment for unused long service leave. This depends upon the length of service with the employer, employment conditions and amounts of leave already taken. Unused long service leave payments received due to genuine redundancy, early retirement or invalidity may be taxed more favourably compared to receipt on resignation or retirement. The table below summarises the tax treatment of unused long service leave payments. Resignation or retirement

Genuine redundancy, invalidity, early retirement*

Leave accrued before 16 August 1978

5% included in assessable income and taxed at marginal tax rate + Medicare

5% included in assessable income and taxed at marginal tax rate + Medicare

Leave accrued 16 August 1978–18 August 1993

100% included in assessable income and taxed at maximum rate of 30% + Medicare

100% included in assessable income and taxed at maximum rate of 30% + Medicare

Leave accrued after 18 August 1993

100% included in assessable income and taxed at marginal tax rate + Medicare

100% included in assessable income and taxed at maximum rate of 30% + Medicare

* ITAA97 s 83-15. A tax offset is applied to ensure that the maximum specified rate of tax only applies. If the person’s marginal tax rate for this payment is greater than 30%, a tax offset is applied so that this portion is taxed at a maximum rate of 30% plus Medicare. If the marginal tax rate is lower, the actual marginal tax rate will apply and any excess tax deducted by the employer can be used to offset other tax liabilities or be refunded in cash. Refer to ¶1-265 for an example showing the apportionment of unused long service leave into these two categories. Payments for unused long service leave are included on the PAYG payment summary given to the employee and PAYG tax must be deducted by the employer.

Tip If a person takes time off to use up their annual leave and/or long service leave before terminating employment, payments for this leave are paid as normal salary and are fully taxable at marginal tax rates. This may be a higher tax rate than if a lump sum is received as payment for unused leave. However, because taking leave lengthens the employment period, consideration should be given to the impact this has upon superannuation entitlements and other employment benefits. This is especially important if the person belongs to an employer or defined benefit superannuation scheme.

¶14-250 Employer payments An employment termination payment, as the name suggests, is paid on the termination of a person’s employment (ITAA97 s 82-130). An employment termination payment received during a person’s lifetime is a “lifetime termination benefit” (considered below). If the employment termination payment is paid due

to the death of the person, it is a death benefit termination payment (¶4-420). Not all payments received on termination of employment are classified as an employment termination payment. When deciding the taxation treatment and recommended use for other employer payments, the amounts need to be categorised between payments that can form part of a life benefit termination payment, and payments that cannot. The following table lists some common payments received and whether such payments are classified as employment termination payments and included as part of a life benefit termination payment. An employment termination payment includes

An employment termination payment does not include

Payment in lieu of notice

Unused annual leave

Redundancy payments in excess of tax-free amount

Redundancy payments within tax-free amount

Unused sick leave

Unused long service leave

Golden handshakes

Salary and wages already completed

Unused rostered days off

Payment for restraint of trade

Severance or termination payments

Compensation for personal injury

In the event of a genuine redundancy or early retirement scheme, a portion of the potential life benefit termination payment is paid tax-free. This amount depends on the length of service with that employer (¶14-260). The portion above the tax-free amount is a life benefit termination payment that is classified into tax-free and taxable components. Life benefit termination payments can only be received in cash. The taxation of life benefit termination payments received within 12 months from termination of the individual’s employment is: Component

Assessable portion

Tax treatment1

Tax-free

Not assessable

Not applicable

Taxable

100%

Under preservation2 age: • Up to $215,000 — 30% • Over $215,000 — Top MTR3 Preservation age2 and over: • Up to $215,000 — 15% • Over $215,000 — Top MTR3

(1) Medicare levy may also be payable. The $215,000 threshold is applicable from the 2020/21 financial year. This threshold may be indexed in future years in increments of $5,000 (ITAA97 s 960-285). (2) Preservation age is increasing from age 55 to 60 depending on a person’s date of birth (refer to ¶4-400). (3) The highest marginal tax rate is 45%.

Note Preservation age is determined on the last day of the financial year (ITAA97 s 82-10). A person may receive a payment during the year while under preservation age; however, they are entitled to the

more concessional tax treatment if they have reached preservation age by the end of the financial year.

The $215,000 cap is reduced by any life benefit termination payments previously received. Components of a life benefit termination payment A life benefit termination payment may consist of two components — tax-free and taxable. The taxable component may be further divided into taxed and untaxed amounts. The tax-free amount consists of an invalidity segment and pre-July 1983 segment. The calculation of the invalidity segment is discussed at ¶14-320. The calculation of the pre-July 1983 segment is calculated by (ITAA97 s 82-155): Life benefit termination payment less invalidity segment

×

Pre-July 1983 days Total number of days

where: Pre-July 1983 days is the number of days of employment to which the payment relates that occurred before 1 July 1983. Total number of days is the total number of days of employment to which the payment relates. 12-month rule An employment termination payment must be received within 12 months (ITAA97 s 82-130) of the individual’s employment being terminated in order for the payment to qualify as an employment termination payment and receive concessional tax treatment. The ATO has discretion to treat certain payments made after the 12-month period as employment termination payments (ITAA97 s 82-130(5)). The following payments received outside the 12-month period are not subject to the 12-month rule: 1. where there was legal action over the person’s entitlement to the payment, or its amount, if the action commenced within 12 months of termination, or 2. the payment was made by a liquidator, receiver, receiver/manager or trustee in bankruptcy, appointed no later than 12 months after termination. Certain payments made from a redundancy trust that are received more than 12 months after the termination of employment may also be treated as an ETP (ATO Determination — ETP 2019/1). If a payment is made outside of the 12-month period and the ATO does not apply discretion, then it is treated as ordinary income and taxed at marginal tax rates. Death benefit termination payments A death benefit termination payment is an employment termination payment that is made to an employee’s beneficiary in the event of the employee’s death. The table below summarises the tax treatment of death benefit termination payments. Tax treatment1

Component Tax-free component

Tax-free

Taxable component

• Payment to a dependant2: – up to $215,000: tax-free – over $215,000: taxed at top MTR

• Payment to a non-dependant3:

– up to $215,000: taxed at maximum rate of 30% – over $215,000: taxed at top MTR

• Payment to a trustee of deceased estate4: – taxed in the hands of the ultimate beneficiary of the estate, as above, based on whether the beneficiary is a dependant or non-dependant (1) Medicare levy may also be payable. The $215,000 threshold is applicable from the 2020/21 income year. This threshold may be indexed in future years in increments of $5,000. (2) ITAA97 s 82-65. (3) ITAA97 s 82-70. (4) ITAA97 s 82-75.

The ETP cap amounts for life benefit termination payments and death benefit termination payments operate independently. That is, a life benefit termination payment received does not count towards the cap on the death benefit termination payment.

¶14-260 Calculating the tax-free redundancy payment For the 2020/21 financial year, the tax-free amount of the redundancy payment is: $10,989 + ($5,496 × years of service) The years of service is the number of completed years of service with the paying employer. It does not include part years (ITAA97 s 83-170). The dollar amounts ($10,989 and $5,496) are indexed each year on 1 July in line with increases in average weekly ordinary times earnings (AWOTE) (ITAA97 s 960-280). Example On 1 July 2020, Donna, age 57, receives a redundancy payment of $95,000, which includes unused sick leave of $5,000 and payment in lieu of notice of $2,000. This gives her a total employer payment of $102,000. She has been with this employer for just under 16 years. This is a genuine redundancy so her tax-free amount is calculated as:

$10,989 + ($5,496 × 15) = $93,429 The difference between her employer payment and the tax-free amount is $8,571 ($102,000 − $93,429). This amount is a life benefit termination payment. It is made up entirely of taxable components because Donna has no pre-1 July 1983 service with this employer.

Tip As termination payments can only be received in cash, if a client is eligible to contribute to superannuation, they may consider making non-concessional and/or concessional contributions to superannuation with this amount. This contribution is subject to preservation rules (¶4-400), eligibility requirements (¶4-205) and the contribution caps (¶4-234 and ¶4-240).

INVALIDITY ¶14-300 Definition of invalidity

If the person’s employment is terminated before age 65 due to invalidity or ill health (mental or physical), concessional tax treatment may apply to any employer payment as well as payments from the superannuation fund. If the person’s terms of employment specify an earlier retirement age than 65, then the person’s employment must have been terminated before this age for concessional tax to apply. To determine invalidity, two legally qualified medical practitioners must have certified that the disability is likely to result in the person being unable to ever be employed in a capacity for which they are reasonably qualified. One of the elements in determining eligibility for an invalidity segment is the “termination of employment”. An invalidity segment can be calculated for employees and self-employed persons (ITAA97 s 82-150 and s 995-1(1)). If the person’s eligible service commenced prior to 1 July 1983, the person is also entitled to a pre-July 1983 segment which forms part of the tax-free amount (ITAA97 s 82-155). The pre-July 1983 segment is calculated by subtracting the invalidity segment (if any) and multiplying this figure by the number of pre-1 July 1983 days divided by total days in the service period. While a person who terminates employment due to invalidity may also satisfy the total and permanent disability condition of release to access their superannuation benefits, this is not necessarily the case. The trustee of the superannuation fund needs to be satisfied that the condition of total and permanent disability specified in the fund’s trust deed has also been met before funds can be released.

¶14-310 Unused annual and long service leave If a payment is made due to invalidity for unused annual leave or unused long service leave, concessional taxation applies to these payments. The same taxation rules apply as for leave payments received upon termination under a genuine redundancy or early retirement scheme (¶14-230, ¶14-240).

¶14-320 Calculation of invalidity segment of a life benefit termination payment If a life benefit termination payment is paid after 30 June 1994 by an employer due to invalidity, the taxfree component is increased to reflect the period the person would have otherwise been gainfully employed. The invalidity segment is a portion of the total life benefit termination payment and is calculated as follows: Amount of life benefit termination payment ×

  Days to retirement   Employment days + days to retirement

where: • days to retirement is the number of days in the period from the date when the employment terminated until the “last retirement date” (generally age 65 unless the employment award or terms specifies an earlier age) • employment days is the sum of the number of days to which the payment relates. Example Jeff terminates his employment on 30 June 2021, his 59th birthday, due to invalidity. His normal retirement age would be on 30 June 2027 when he turns 65 because there is nothing in his employment award to specify an earlier age. He receives a life benefit termination payment of $200,000 (consisting of taxable component only) and his service period commenced on 1 February 1990. The components of the superannuation lump sum will be altered to reflect an invalidity amount which is part of the tax-free component.

Tax-free component (ie invalidity = segment) =

$200,000 × [2,192/(11,473 + 2,192)] $32,082

The tax-free component of $32,082 is received tax-free. The balance of the life benefit termination payment is taxable component.

Tip It is likely that a person who ceases work and meets the invalidity definition will also meet the definition to allow an uplift in the tax-free component on withdrawals from superannuation (ITAA97 s 307-145).

¶14-330 Calculation of disability benefit of a superannuation lump sum

Note The calculation of a disability benefit from superannuation is fundamentally the same as calculating an invalidity segment of a life benefit termination payment.

If a superannuation lump sum is paid after 30 June 1994 from a superannuation fund due to invalidity, the tax-free component is increased to reflect the period the person would otherwise have been gainfully employed. The increase in the tax-free component is possible if the trustee pays a “disability superannuation benefit” (ITAA97 s 295-460). A disability superannuation benefit is a superannuation benefit if: • the benefit is paid because the person suffers from ill health (physical or mental), and • two legally qualified medical practitioners have certified that, because of the ill health, it is unlikely that the person can ever be gainfully employed in a capacity for which the person is reasonably qualified by education, experience or training (ITAA97 s 995-1). The increase in the tax-free amount is a portion of the total superannuation lump sum and is calculated as (ITAA97 s 307-145): Amount of benefit

×

  Days to retirement   Service days + days to retirement

where: • days to retirement is the number of days from when the person stopped being capable of being gainfully employed until the “last retirement date” (generally age 65 unless the employment award or terms specifies an earlier age) • service days is the sum of the number of days in the service period for the lump sum.

Note The ATO has provided guidance that a modification is made to the denominator to ensure that days that are captured in “service days” and “days to retirement” are only counted once.

OTHER ISSUES REGARDING TERMINATION PAYMENTS ¶14-425 Superannuation contribution caps A life benefit termination payment can only be received in cash. A contribution to superannuation could be considered if this is the most appropriate investment vehicle. There are two issues to consider — eligibility to contribute to superannuation and the contributions caps. In order to make a contribution to superannuation the person must be either: • under age 67, or • aged 67–74 and satisfy a work test in the financial year the contribution is made (unless the work test exemption applies (¶4-205)). In addition, the individual’s total superannuation balance may also impact contribution strategies. Further details on the contribution rules can be found at ¶4-205. The government limits the amount of contributions that can be made to superannuation — both concessional and non-concessional. A person may contribute the life benefit termination payment to superannuation but must consider the contribution caps. The caps limit the amount which can be contributed to superannuation without attracting penalty tax. Further details on the contributions caps can be found at ¶4-220 to ¶4-250.

¶14-430 Social security If employment is terminated, consideration may be given to replace income with social security to assist meeting income needs. Consideration needs to be given to which payment the person may be eligible for (¶6-100), how long before payments commence (ie the impact of waiting periods (¶6-700)) and the amount of payment to be calculated under the income and assets tests. If a person under Age Pension age terminates employment due to a genuine redundancy or early retirement scheme, they will generally only be eligible for JobSeeker Payment (¶6-190). If employment is terminated due to invalidity, a person under Age Pension age may be eligible for Disability Support Pension (¶6-180). The social security rules for determining disability are different from those for taxation or superannuation purposes so it is not automatic and the person may have to apply for JobSeeker Payment. Pensions are favoured over an allowance due to the more lenient income and assets tests rules. Payments received upon termination of employment may impact on the waiting periods before income support is payable. These payments are included in means testing to determine the amount of income support payable. Regardless of the type of payment, money held in a superannuation or rollover fund is an exempt asset for a person under Age Pension age (¶6-610). Therefore, using superannuation can be an effective strategy for increasing eligibility for social security support. This may include retaining benefits in superannuation or contributing employment payments into superannuation. However, consideration needs to be given to the tax paid within superannuation and cost compared to the entitlement received from social security. Paying off personal debts can also assist to increase the eligible payment amount. Income maintenance period The full amount received from the employer is used to calculate the Income Maintenance Period (IMP). This includes payments for unused leave (including annual leave, long service leave and sick leave) and the tax-free portion of a redundancy and life benefit termination payment. The gross amount of payments is treated as income from the date of payment over a period equal to the number of weeks the leave was paid to determine income for social security purposes (¶6-730). This “income” is added to other income to assess eligibility for income support. This generally means no income support is payable for a period of weeks equal to the amount of unused

leave the person is entitled to. Liquid assets waiting period A person applying for certain entitlements may serve a liquid assets waiting period (LAWP) (¶6-720) of up to 13 weeks plus the one week normal waiting period (¶6-705). No entitlement is payable in this period. The waiting period starts the day after employment ends (even if an application for benefits is made at a later date). The length of the waiting period depends on the amount of liquid assets. These are counted as the higher amount held at the date when either: • employment ceases, or • the application for the allowance is submitted to Centrelink. Liquid assets include gross employer payments (both taxable and tax-free amounts) made or due to be paid from the date employment is terminated. However, liquid assets do not include superannuation funds. As life benefit termination payments are received in cash, these payments are generally included in the calculation of the LAWP. The LAWP and the IMP run concurrently. Some individuals may not be required to serve the LAWP, which may include that the person has “selfserved” (ie time from test date to application date is outside the application of the LAWP) or if the government has waived the requirement (eg in response to COVID-19 or financial hardship). Further information can be found at ¶6-720.

Tip It is important to understand these rules and calculate the length of any waiting period because consideration should be given to how the person will meet their income needs during this period. The waiting period from an IMP can be quite lengthy.

¶14-440 Invalidity segment — whether to receive as a lump sum or pension Example Sean was born on 11 August 1967 and is 53 years old. He was involved in a work-related accident and ceased work on 28 May 2021. Sean is unable to return to work in his previous role and will receive an invalidity payment from his employer. He commenced working for his employer on 1 July 2000 and his normal retirement age is 65. The life benefit termination payment is for a total of $500,000 consisting of:

Taxable component (untaxed)

$325,505

Invalidity segment

$174,495

The invalidity segment is calculated as:

$500,000 × 4,094/11,731 = $174,495 Sean is also a member of the JE Consulting Employee’s Superannuation Fund with a balance of $300,000 (consisting of $11,592 tax-free component and $288,408 taxable component). This fund requires members to be employees of JE Consulting. Because Sean has ceased work with this company, he is no longer eligible to be a member of the superannuation fund. He has written to the trustees of the fund requesting release of his benefits and to calculate a disability superannuation benefit. He has provided medical evidence of his injury and inability to work. The trustee accepts that Sean meets the total and permanent invalidity condition of release, changes the preservation status to unrestricted non-preserved and calculates the disability amount which increases the tax-free component. The disability benefit is calculated as:

$300,000 × 4,094/11,731 = $104,697 The available superannuation lump sum is:

Tax-free component

$116,289

Taxable component (taxed)

$183,711

Because a condition of release has been satisfied, Sean can take both the life benefit termination payment and superannuation lump sum in cash. Sean is under his age preservation age so if the full benefit is taken in cash, he must consider that the entire taxable component is taxed (ie no low rate cap applies). If Sean rolls over his superannuation to another superannuation fund, he will be able to make lump sum withdrawals as he has satisfied a condition of release. He will still need to consider the tax implications of any future withdrawals. Withdrawals from superannuation must be drawn proportionally from the tax-free and taxable components (¶1-285). Sean may consider contributing part of his life benefit termination payment to superannuation. A person under age 67 can contribute non-concessional contributions to superannuation of up to $300,000 by bringing forward future contributions caps and as his total superannuation balance is less than the general transfer balance cap. However, if after allowing for lump sum tax on the life benefit termination payment, the net amount received was above $300,000, Sean should limit the contribution to the cap amount. He must also consider any other non-concessional contributions made during the last three years to avoid breaching the cap and triggering the penalty regime. This could be used to commence a superannuation income stream. If he applies to the fund provider or trustee to pay this pension due to disability, Sean will be entitled to receive the 15% pension tax offset (¶16-770). He will need to re-submit medical evidence to the new account-based pension provider and satisfy their conditions to ensure it is paid as a disability pension. A portion of Sean’s income stream will be tax-free (¶16-750). This is based on the proportion of the tax-free component to the entire benefit at the commencement of the income.

¶14-450 Investing payout versus paying off debt Example Rex is married to Niki and has been offered a genuine redundancy that he plans to accept. They are both aged 58 and their current financial situation is:

Home

$380,000

Car/contents

$50,000

Bank account

$10,000

Unit trusts

$30,000

Super — Rex

$250,000

Super — Niki

$80,000

Upon termination of employment (after 21 years of service), Rex expects to receive payments for:

Unused long service and annual leave

$38,000 (after tax)

Redundancy payment from employer: – tax-free

$126,405 (for 2020/21)

– life benefit termination payment (taxable component)

$23,595 (gross amount)

They still owe $110,000 on their home loan. With monthly payments of $1,226 and an interest rate of 6.07% pa, they expect to pay the loan off in 10 years. They also owe $7,000 on credit cards, with an interest rate of 16.65%. Niki is working part-time. However, they feel they have not accumulated enough savings to enjoy a comfortable retirement, so Rex will look for new employment. They need to generate more income to replace Rex’s salary and meet their current living expenses. Rex and Niki can use superannuation to maintain their assets below the social security assets test threshold of $401,500 (as at 1 July 2020) so Rex can apply for JobSeeker Payment. Rex can only receive all employer payments in cash. They wonder if they should invest all his employer payments into super (as a new contribution) or whether he should use this money to pay off their debts. While this decision will include consideration of many lifestyle issues, this example only considers the financial implications. He has not previously taken any life benefit termination payments so if the life benefit termination payment is taken in cash, tax of $4,011 is deducted (ie $23,595 × 17%). If the home loan is paid off, they save interest of $37,120, ie [$1,226 × 12 × 10] − $110,000. This can be compared to investing the

$110,000 into super with an assumed net return in the fund of 8% pa. Over the next 10 years, the superannuation balance grows to $237,482, producing a total return of $127,482. It may appear that rolling over to super, rather than paying off the debt, produces a better result. However, consideration needs to be given to what is done with the $1,226 per month that would otherwise be paid as home loan repayments. It is assumed Rex and Niki pay off their home loan and invest the repayment amount each month into superannuation, producing 8% pa net return. At the end of the 10-year period this would have grown to a balance of $213,126, with a return of $66,006. Provided they are disciplined to continue the savings plan, the strategy to pay off the home loan and invest the repayment amount into super gives them an effective return of $103,126 (ie $66,006 + $37,120). Given these assumptions, Rex and Niki achieve a better outcome by continuing with the home loan and investing his redundancy payout into super. However, the outcome will vary significantly depending on particular circumstances. The outcome varies depending on the interest rates, remaining term of the loan, alternative investment option used as a comparison and taxation situation. This example should only be used as a guide for issues to consider in making a comparison. If the decision is made to pay off the home loan, the clients should be encouraged to continue with a savings plan using the former repayment amount.

PLANNING TO RETIRE The big picture

¶15-000

Retirement Why plan for retirement?

¶15-005

Building a capital base for retirement

¶15-010

The power of compounding returns

¶15-015

Risk return and time horizons

¶15-017

Why or why not superannuation? Why superannuation?

¶15-020

Why not superannuation — need for access flexibility

¶15-025

Alternative investment strategies to superannuation

¶15-035

Comparison of superannuation and non-superannuation

¶15-040

Contributing to superannuation Contributing to superannuation

¶15-045

Non-concessional contributions

¶15-048

Concessional contributions

¶15-050

Salary sacrifice contributions

¶15-100

Transitioning to retirement

¶15-110

Re-contribution strategy and maximising the tax-free component ¶15-180 Spouse contributions

¶15-190

Spouse contribution splitting

¶15-192

Government co-contribution

¶15-195

Downsizer contributions

¶15-198

CGT and small business Small business and superannuation

¶15-200

Small business retirement issues

¶15-210

Preservation Preservation rules

¶15-400

Other planning issues Consolidation of superannuation benefits

¶15-510

Financial and lifestyle issues

¶15-520

Accepting the fact of retirement

¶15-530

Budgeting for retirement

¶15-540

How health issues affect retirement

¶15-560

Where to live post-retirement

¶15-570

Insurance needs after retirement

¶15-580

Estate planning

¶15-590

¶15-000 Planning to retire

The big picture Why plan for retirement?: The financial planner’s role in assisting clients with their retirement planning is becoming increasingly important as Australians face the dilemma of a rapidly ageing population. ¶15-005 Building a capital base: Retirees need to survive on the income they can derive from capital accrued during their working life, with a supplement from the Age Pension (if eligible) and top-ups from capital drawdowns. Therefore an adequate capital base is needed to provide income and manage longevity risk. ¶15-010 Why superannuation?: Superannuation is a tax-effective investment structure within which to hold investments. The downside of superannuation is the lack of access to funds under the preservation issues. ¶15-020–¶15-035 Comparison of superannuation and non-superannuation strategies: A case study has been provided which compares the results of a superannuation salary sacrifice arrangement (or personal deductible contribution) with investing after-tax salary income outside of superannuation. ¶15-040 Contributing to super: When making contributions to superannuation, several choices need to be made — whether to make a concessional or non-concessional contribution, and for couples, determining in whose name the contributions should be made. ¶15-045 Salary sacrifice contributions: Employees are able to claim a tax deduction for contributions to a superannuation fund, so when would salary sacrifice still be effective for employees. ¶15-100 Transitioning to retirement: Individuals have the option of accessing their superannuation benefits as a non-commutable income stream while still working, provided they have reached preservation age. ¶15-110 Re-contribution strategy: Re-contribution strategies may assist to alter the tax components proportions in the super fund by increasing the tax-free portion. However, individuals need to meet certain criteria to be eligible. ¶15-180 Spouse contributions and splitting: Couples may wish to use strategies to create a more even split on superannuation between each person. ¶15-190–¶15-192 Government co-contribution: A government co-contribution may be available for lower income earners where specified criteria are met. ¶15-195 Downsizer contributions: The home often forms a large part of retirement resources. If sold and surplus funds become available, this might be used to top up superannuation balances. ¶15-198 Small business capital gains tax (CGT) concessions and superannuation: The small business CGT concessions recognise that small business owners often have their assets tied up in growing their business, leaving them without significant cash flow to build up their superannuation assets. A case study is provided to illustrate how the small business CGT concessions work in practice. ¶15210 Preservation rules: The trade-off for superannuation being taxed concessionally is that benefits are preserved until a condition of release can be met. ¶15-400 Other planning issues: Investing available funds is part of the retirement planning process, but other issues such as accommodation, lifestyle and health considerations are also important to consider in the planning process. ¶15-510–¶15-590.

RETIREMENT ¶15-005 Why plan for retirement? Planning for retirement, from both a lifestyle and a financial perspective, should be part of your clients’ long-term wealth creation process. Clients who plan carefully long before retirement will generally be the most successful. Clients who defer putting into place a retirement plan until retirement becomes imminent, may not leave enough time or scope to create sufficient wealth, especially if they face early retirement through redundancy or ill-health. The financial planner’s role in assisting clients with their retirement planning is becoming increasingly important as Australians face the dilemma of a rapidly ageing population. This role is reinforced by the Financial Adviser Standards and Ethics Authority (FASEA) code of ethics which states that advisers need to take into account the client’s broader long-term interests. This includes planning for frailty and aged care as part of the retirement period. Currently in Australia there are five people of working age for every person over age 65. By 2031, it is estimated that there will be less than three people of working age for every person over 65. This will put an enormous strain on the government’s revenues to fund the Age Pension and aged care. The Age Pension age is increasing up to age 67, and this may widen the gap between retirement and qualification for the age pension. Australian Bureau of Statistics data in 6238.0 Retirement and Retirement Intentions, Australia, 2018-19, indicates that 55% of people over age 55 are retired, with an average retirement age of 55.4. Many people approaching retirement have little idea how much income or capital is required. The ASFA research on retirement living standards for March 2020 suggests that a couple around age 65 requires income of $62,435 and a single person requires $44,183 each year to be “comfortable” in retirement. This suggests that the Age Pension provided by the government is very much a safety net and not an adequate income level for most people. Successive governments have introduced initiatives to address the budgetary problems by encouraging greater self-sufficiency. These initiatives have been aimed largely at: • increasing superannuation coverage of the Australian population through award superannuation and the introduction of the superannuation guarantee (SG) scheme in 1992 with the rate progressively increasing up to 12% by 1 July 2025 • preventing leakages from the superannuation system through the introduction of roll-overs in 1983 and changes to, and continual tightening of, the preservation rules • providing incentives for people to contribute to superannuation through tax concessions • tightening of means-testing arrangements for the Age Pension as well as increases in eligibility age • increasing retirement options, such as encouraging part-time retirement, and • reforms to the aged care sector.

¶15-010 Building a capital base for retirement Retirees need to survive on the income they can derive from capital that has been accrued during their working life, with a supplement from the Age Pension (if eligible) and top-ups from capital drawdowns. Therefore, an adequate capital base is needed to provide income and manage the longevity risk. Many clients in the accumulation stage do not fully appreciate the size of the capital (asset) base they will need to accumulate to meet their income needs and maintain their lifestyle in retirement. Unless a retiree has access to other sources such as salary or wages, an insufficient lump sum will not keep pace with the

demands that are placed on it by the retiree and it may diminish at a rapid pace. The role of a financial planner is to guide the client through the planning process and provide the client with the necessary information to help them decide when they can afford to retire. Once in retirement, the planner’s role extends to continuous monitoring of the client’s cash flow to ensure they can manage their funds to maintain their desired lifestyle for the period required. The planning process should also give consideration to the fact that income needs may change and vary throughout retirement. For example, discretionary and entertainment expenditure may be higher in the early “active” years of retirement. Overall expenditure may reduce as a client moves towards frailty in the “quiet” years, but then pick up and potentially be at its highest point in the “frailty” years when expenditure on care options can help to provide quality of lifestyle as well as quality care support. A variety of approaches can be used to assist with calculating the capital base required. Modifications may be needed to increase or decrease the calculated amount depending on individual estate planning goals, degree of investment and mortality risk, and retirement goals. However, one mainstream approach uses the present value formula. Based on a few core assumptions, the present value formula can be used to determine things such as: • how much capital a client needs in retirement to fund their specific lifestyle needs • when they can afford to retire, and • what retirement income they can expect. There are many software packages and financial calculators available that allow planners to sit down with clients and show them the value of their investments and expected retirement incomes. Generally, they are all based on the following formula: -n An =  R (1 − (1 + r) )    r

where: An = the present value of an ordinary annuity r = real rate of return for their risk profile n = number of years in retirement (life expectancy) R = required gross annual payment in today’s dollars. Note: The real rate of return (r) equals the nominal interest rate (i) minus the rate of inflation (π). That is r = i − π. Example Brooke, age 40, requires a gross income of $40,000 pa in today’s dollars in retirement at age 65. Her life expectancy at age 65 is estimated at 22.34 years (using the 2015/17 Life Tables issued by the Australian Government Actuary) and as she is a “balanced” investor, a return of 4.5% pa above the inflation rate (assumed at 2.0%) is expected. The capital amount required for Brooke to be able to afford to retire given these parameters is:

An = 

40,000 (1 − (1 + 4.5/100)−22.34)  4.5/100 

= 

40,000 (1 − (1 + 0.045)−22.34)  0.045 

= 

$556,390

It should be realised that this amount is in today’s dollars. The actual nominal amount needed at age 65 is calculated as:

Amount in 25 years = Present dollars × (1 + inflation rate)n = $556,390 × (1 + 2%)25 = $912,818

The calculation above assumes Brooke needs to accumulate a capital base of $556,390 in today’s dollars to generate the required level of income for 22.34 years, to her statistical life expectancy which is applicable from the age of 65 (as per the life table), when she retires. This is her expected retirement period. Many prudent planners are allowing for a greater lifespan due to increasing life expectancy and future changes, especially given that the tables are based on average life expectancies. The averaging nature means that each person has a 50% chance of living beyond the calculated age. This makes planning a difficult exercise, and flexibility should be included to address the issues of longevity. Planners can calculate if a person is on track to meet their retirement goal by using the future value formula to determine how much each savings contribution needs to be to accumulate the required lump sum goal. It will also allow a planner to continually review the client’s position to check that they are on track to achieving their desired level of retirement income, taking into account their current savings, regular savings pattern and actual investment returns. R = 

FV − [An (1 + r)n]    [(1 + r)n − 1]/r

where: R = regular annual savings contribution required to meet retirement goal FV = required level of capital at retirement An = present value of current investment balance r = annual real rate of return for their risk profile, divided by 100 n = number of annual contributions to be made until retirement. Example Alyssa is 40 years old and wants to retire at age 65 on $40,000 income in today’s dollars ($83,751 future dollars). Alyssa currently has $75,000 in investments and will require a lump sum of $556,390 (as calculated in example above). A balanced return of 4.5% above inflation is expected, ie 7.5% pa with an inflation rate of 2%. The annual contributions that Alyssa will need to save to meet this level are as follows.

Contribution =  = 

$556,390 − [$75,000 (1 + .045)25]   [(1 + .045) 25 − 1]/.045 $7,427

It is important to note that the $7,427 is the amount that needs to be saved in “real terms”, ie next year the amount to save would need to be $7,576 ($7,427 × 1.02) to take into account inflation of 2%. The calculations to determine the required level of retirement assets do not take into account any tax considerations, which if you structure your client’s affairs well, will usually be minimal for retirees under current rules. They also assume that the client will fully self-fund the required level of income. The same income level can be generated with a lower capital base depending on the support provided from the Age Pension.

¶15-015 The power of compounding returns Compound growth refers to the process of increasing capital by reinvesting income. More capital leads to more income, even if the rate of return is the same. As capital grows, so does income.

The chart below shows the power of compounding and how the growth accumulates over time if returns are invested. In this example, the investment commences with $20,000 and earns 6% pa each year which is fully reinvested.

Source: ASIC, MoneySmart website, Compound Interest Calculator Over a period of 30 years, the $20,000 investment grows to $114,870. The table below shows how the compounding effect accelerates earnings over time, with the earnings added in each five-year time period being higher than the amount added in the previous five years. Time period

Earnings added in the time period

0 to 5 years

$6,765

5 to 10 years

$9,052

10 to 15 years

$12,114

15 to 20 years

$16,212

20 to 25 years

$21,694

25 to 30 years

$29,033

The principles of compounding interest apply equally to superannuation and non-superannuation investments. The longer the period that the money is saved, the more powerful the compound interest effect is. The earlier you start saving, the more you make from compound interest. The same principle applies to other investments such as shares if dividends are reinvested.

¶15-017 Risk return and time horizons When selecting how to structure an investment portfolio, clients need to consider the trade-off between risk and return. This then requires a view on portfolio construction strategies to create an effective solution for each client. The most appropriate solution for a client needs to be developed with consideration for the client’s ability to accept investment risk, their financial situation and objectives as well as the expected investment time frame. As a general rule, the period of time over which investors expect to have their money invested largely guides the appropriate areas of investment. For short-term time horizons, investments with a high degree

of capital security, such as cash management facilities and term deposits, may be more suitable. With a longer investment term (say, five or more years), capital growth investments such as shares and property can be introduced. Time is the essential ingredient needed for capital growth investments to achieve their potential. With time on your side, the fluctuating nature of many investment markets may become less important. In the longer term, growth investments are generally expected to provide better returns (see ¶9-070 for a discussion on risk versus return trade-off) and you may be able to wait for the markets to pick back up and produce a positive result. However, this is a very simplistic view and investment strategies are focusing more on the implications of sequencing risk and not just time in the market. Sequencing risk is based around the fact that investment markets are volatile and the impact on the value of an investment portfolio depends on the sequence (or order) in which investment returns occur. If negative returns occur when the investment balance is at its greatest, they will have a more devastating effect than if the same percentage loss occurs when the balance is lower. Sequencing risk is therefore the risk that the portfolio will experience poor returns when it has the worst impact on longevity of the portfolio. For clients, the impact of a negative return close to retirement (at the end of accumulation) or in the early years of retirement is likely to have a greater impact on the portfolio value than earlier in the savings stage. Strategies to manage sequencing risk could include: • diversification across and within asset classes • dollar cost averaging when accumulating as well as when drawing down • using a portfolio investment theory that adjusts asset allocations and product options based on life stages. Some investment theories consider that clients should start shifting towards more conservative asset allocations as they start to approach retirement to minimise investment volatility when balances are at their highest. However, clients could still be facing 20+ year investment timeframes when they retire and a portfolio that is too conservative may sacrifice the opportunity to generate sufficient returns to sustain the required longevity of their savings. Another theory promotes purchasing lifetime or long-term annuities to lock in regular income to cover the essential income needs of a client. With base needs secured, this may allow the client to take greater levels of risk with the balance of their savings and can help to manage sequencing risk in the early stages of retirement. A third set of theories looks at setting aside the income needs for the first few years of retirement in a cash or fixed interest environment, so that growth investments have a greater chance to ride out any volatility before drawdowns need to be made. The right solution depends on the client’s personal preferences, circumstances and risk tolerance. It is therefore important that clients take an active interest in where and how their money is invested. Many people adopt conservative attitudes to their investments because they think they will lose their money if they invest in shares or property. Instead they place their money into the cash option. Effectively, they are protecting their investments against capital loss. But if the return they receive does not even make up for the impact of inflation in a real sense their investments may only be “treading water” or going backwards. For clients looking to create wealth, a more aggressive strategy for their superannuation investments may allow them to reduce how much needs to be saved to free up funds for their needs outside superannuation. An effective long-term plan that focuses on providing for retirement may allow clients to seize opportunities as they arise and create greater financial stability or improve current lifestyle. As long as they are confident their future is provided for, clients may choose to safely use what money is left for today.

WHY OR WHY NOT SUPERANNUATION? ¶15-020 Why superannuation? Many people make the mistake of considering superannuation to be a specific investment option. Rather, superannuation is simply a tax-effective investment structure within which to hold investments. The same underlying investments can be held within superannuation (subject to superannuation and trust law constraints) as outside superannuation. Superannuation continues to be tax-effective compared to non-superannuation. How tax-effective it is may depend on the person’s own level of taxable income, superannuation balance, age and type of contribution made. The concessional environment encourages clients to invest in superannuation for retirement savings, particularly with the attraction of tax-free withdrawals or income streams from age 60. When clients are in the wealth accumulation phase of their lives, their financial plans will focus more on growth. While many forms of investment outside superannuation offer growth, the tax advantages of superannuation may produce a higher effective net or internal rate of return after tax. Tax concessions on superannuation can continue into the retirement phase. The tax structure of superannuation provides tax benefits at all stages of life. For example: • contributions made to superannuation may attract tax deductions, offsets or even a government cocontribution (see ¶4-200 to ¶4-275 for the tax deductions, offsets and co-contribution available on the various types of contributions) • investment earnings and any realised capital gains in the accumulation phase (including transition to retirement income streams) are subject to a maximum tax rate of 15%, rather than marginal rates, with tax payable on only ⅔ (two-thirds) of the realised capital gains (see ¶4-300 to ¶4-340 for the taxation of superannuation funds) • investment earnings (including realised capital gains) in the pension phase (not transition to retirement income streams) are not taxed • concessional tax rates on end benefits, with all benefits withdrawn after age 60 from a taxed superannuation fund (as lump sums or pension payments) being tax-free (see ¶1-285 for the taxation of superannuation benefits). In essence, the tax benefits of superannuation arise from either a higher net contribution (due to concessions on contributions) or lower tax on earnings (arising from a lower income tax rate and the taxfree status after age 60). Even in accumulation phase (including a transition to retirement pension), the effective tax rate that a superannuation fund pays is usually lower than 15%. This is because of deductions for superannuation fund expenses including insurances, the depreciation allowances claimable on property investments, franking credits from Australian share investments and the capital gains discount on assets held for more than 12 months. Example Julie and Martin are both 47 and each earns $75,000 a year. They both have $5,000 of before-tax income that they can invest each year for the next 20 years. Julie decides to salary sacrifice into superannuation. Martin takes his $5,000 as salary and pays tax at his marginal rate before investing into a non-superannuation investment. Both investments earn the same gross rate return of 8% pa over 20 years (although the net tax rate will vary due to the lower rate of earnings tax in superannuation).

The difference in savings after 20 years results solely from the differing tax treatment. Julie has 15% tax deducted in the fund from the $5,000 invested each year (provided concessional contribution caps are not exceeded) and 15% earnings tax (assume maximum earnings tax) is paid within the fund. This contrasts to Martin who pays a marginal tax rate of 32.5% plus Medicare on the $5,000 before it can be invested, and the same rate on investment earnings. Julie could also achieve the same results by making personal contributions to superannuation and claiming a tax deduction instead of salary sacrifice, although there is a slight variation due to a timing difference on the tax benefits. Even if we now compare after-tax (non-concessional) superannuation contributions for Julie versus investments held in Martin’s name outside superannuation, the lower tax on superannuation fund earnings provides a better result for Julie (assuming the same gross rate of return).

Note: If Julie withdraws her superannuation benefits before age 60, lump sum tax may apply to reduce the available balance. It is assumed in both examples that all earnings are income and any CGT considerations are ignored. CGT may still be more concessionally taxed inside superannuation. Tax offsets are ignored in calculations. The second example illustrates that if Julie decides to neither salary sacrifice nor make deductible contributions, she may still be better off by investing within the superannuation system as a non-concessional contribution due to the lower tax rate on earnings. However, restrictions on access to the superannuation funds need to be considered in conjunction with the taxation merits of superannuation. While full access to funds will require a condition of release, typically permanent retirement after preservation age or attaining age 65, Julie may be able to access these funds as an income stream once a condition of release has been met. In this example, the tax rate of superannuation accumulation funds has been the focus. Further tax benefits accrue when you commence an income stream. The tax payable on a superannuation fund in the income stream stage is nil. In fact, the fund can receive a tax refund for any available imputation credits. Benefits withdrawn over age 60 are also received tax-free (from a taxed fund). Note: From 1 July 2017, the amount that can be rolled over to start an income stream is limited to the applicable transfer balance cap. The general transfer balance cap remains at $1.6m per person in 2020/21.

¶15-025 Why not superannuation — need for access flexibility The downside of superannuation is the lack of access to funds before a condition of release is met (see ¶15-400). This means money is generally locked away until retirement after preservation age. Preservation age is age 55–60 depending on the client’s date of birth, but for anyone who has not yet reached preservation age, the age is now at least 57. There is always a potential that legislation could be change to increase preservation ages further in the future. The taxation and investment rules, as well as the client’s own needs and objectives, will determine whether superannuation is appropriate or not. It is recommended that a variety of investment structures are used to meet client goals and objectives, and to create flexibility for access to money throughout the various life stages.

For some retirees, the reality will be disappointingly bleak. Surveys conducted by interested parties such as the government and financial planning groups show that the majority of people only consider planning for their retirement when they are within five to 10 years of the event. Superannuation maximises the effect of the two driving forces behind wealth creation — tax concessions and compounding returns. The restricted access to superannuation benefits before retirement generally means that people have a time horizon that is long enough to take advantage of these two forces. As a result of legislative change that has significantly reduced contribution caps over time, clients should be encouraged to plan and start saving earlier to achieve the required outcomes. The reductions mean there is less opportunity to catch up later in a person’s working life.

¶15-035 Alternative investment strategies to superannuation People increasingly realise that they need to fund their own retirement. The preservation age means clients born after 30 June 1964 generally cannot access their superannuation benefits until age 60 (and meet retirement condition of release). Constant legislative changes and the complexities of superannuation have served to create a wariness around superannuation, and many other strategies have been developed as an alternative for wealth accumulation, for example, gearing and insurance bonds. The cuts in contribution caps have limited the ability to use superannuation as a savings strategy. Gearing is simply borrowing money to invest to achieve leveraging of returns and to allow the immediate acquisition of more expensive assets. The borrowing costs of income-producing geared investments may be tax deductible, providing some taxation effectiveness to help build wealth. A common lending structure is to use margin lending accounts (via direct shares and managed funds), where a set percentage of shares or a managed fund is purchased with borrowed money and margin calls are required to be met as markets fluctuate or the “margin” is exceeded. Periods of market volatility have seen many clients lose large sums of money in some circumstances. Gearing does not suit all clients. It is generally better suited to clients with higher risk tolerance levels who have assets or income resources to pay the ongoing costs including fees, interest and margin calls. Gearing works not only for shares but also for other growth-oriented investments (including property). Self managed superannuation funds (SMSFs) can leverage provided the loan is appropriately structured under a limited recourse lending arrangement. This strategy was becoming popular, but finance for a limited recourse borrowing arrangement has become harder to obtain due to changes in bank lending policies. It is also important to note that tax deductions cannot be claimed for the interest cost of money borrowed to make a contribution into superannuation (unless an employer is borrowing to make contributions for employees as a legitimate business expense). Gearing is discussed in ¶11-000 and margin lending at ¶11-350. Gearing for SMSFs is discussed at ¶5360 and ¶11-520. Insurance bonds can provide tax advantages for higher income earners who have a marginal tax rate higher than 30%. Similar to superannuation, an insurance bond is a tax structure for holding investments. Legal ownership of the investments is held by the insurance company or friendly society. It is the life company or friendly society that pays the tax on earnings each year at the rate of 30%. This may, however, be more tax-effective than paying tax on earnings at the client’s marginal tax rate, but note that the life company or friendly society does not receive discounts for realised capital gains and these amounts are fully taxable at the company tax rate of 30%. Other deductions available to the company may reduce the overall effective rate.

¶15-040 Comparison of superannuation and non-superannuation Some clients might wish to compare a strategy using either salary sacrifice or deductible contributions against an investment strategy outside superannuation, due to the superannuation preservation rules. They might ask the question of whether the tax benefits of salary sacrifice or deductible contributions compensates them for the lack of access to their funds.

In the following example, a superannuation salary sacrifice arrangement is compared with receiving aftertax salary and investing outside superannuation. Example Joshua is aged 55 and plans to retire at 60. He currently has $150,000 in superannuation and is considering whether he would be better off asking his employer to salary sacrifice $10,000 of any annual bonus or taking the $10,000 as salary and investing it. Joshua’s total taxable income for the year totals $210,000.

Assumptions – Annual investment contribution (made at start of year) = $10,000 (pre-tax amount) and earnings are added at the end of the year. – The money is invested in a diversified option earning a gross return of 8% pa (3% income and 5% capital growth). – Joshua’s marginal tax rate is 45% plus Medicare levy. – After-tax income from the managed investment is reinvested each year. – He does not exceed the concessional contribution cap of $25,000 for 2020/21. – For simplicity it is assumed the superannuation fund pays tax at the maximum rate of 15% pa. This does not take into account fund expenses, franking credits or the CGT discount on the realisation of assets held for more than 12 months. For Joshua’s non-superannuation option, it has been assumed no capital gains are realised until year five with the full 50% CGT discount available.

Superannuation Year 1

Year 5

$

$

Nil

40,187

Investment

10,000

10,000

Less: contributions tax

−1,500

−1,500

680

3,895

−102

−584

$9,078

$51,998

Year 1

Year 5

$

$

Opening balance

Nil

24,931

Bonus (to invest)

10,000

10,000

Less: PAYG including levies

−4,700

−4,700

Add: income @ 3%

153

907

Less: income tax plus levies

−72

−426

Nil

−1,020

255

1,512

Opening balance

Add: fund earnings Less: earnings tax @ 15% Closing balance

Managed investment (unit trust)

Less: CGT on disposal Capital growth @ 5%

Closing balance

$5,636

$31,204

In analysing the outcomes over the five years, the salary sacrifice accumulates an extra $20,794 compared to the nonsuperannuation managed fund: – the lower taxation applied to the superannuation contributions (15%) as opposed to salary (45% plus levies) allows a significantly greater investment on an annual basis and this effect compounds over the five years – the taxation rates on income and capital gains of 15% in superannuation are significantly lower than the 45% plus levies applied to the income from the managed investment, and once again this effect compounds. What happens if Joshua was actually paying tax at 32.5% (plus Medicare levy but ignoring other tax offsets)? The closing balance from the managed investment option improves to $39,332, but the salary sacrifice superannuation option is still significantly better at $51,998. Salary sacrifice or deductible contributions Prior to 1 July 2017, employees only had the option to use salary sacrifice to make tax concessional contributions, but anyone who meets the age and work tests to contribute to superannuation can now choose to claim a tax deduction for personal contributions. This means employees can choose to either arrange salary sacrifice with their employer so that contributions are paid from pre-tax salary or to make personal contributions from after-tax contributions and claim a refund of tax paid through deductions claimed in their tax return. The end tax outcomes are the same, the differences are in the administration and the timing of the deductions (ie at point of salary payment or at end of year through lodging a tax return) (¶15-050).

CONTRIBUTING TO SUPERANNUATION ¶15-045 Contributing to superannuation Contributions to superannuation are restricted by rules as to how, when and how much may be contributed (¶4-000). This section discusses the strategic opportunities of contributing to superannuation. To properly assess how superannuation fits into a client’s wealth creation strategy, an understanding of the following three aspects is essential. (1) The three ways that money can be invested into superannuation are: (a) contributing for one’s-self (personal deductible (concessional) contributions and nonconcessional contributions) (b) contributing for others (spouse contributions, spouse contribution splitting) (c) contributions by others (employer, salary sacrifice, SG contributions and government cocontributions). (2) The tax position of the client with regard to taxation of contributions and earnings on those contributions. (3) The client’s time horizon, with regard to access to superannuation, time of retirement and desired lifestyle in retirement. When making contributions to superannuation several choices need to be made — whether to make a concessional or non-concessional contribution and, for couples, to determine in whose name contributions should be made. These decisions will take into consideration the client’s marginal tax rate and how this may affect the overall attractiveness of superannuation. Any wealth creation strategy needs to be reassessed on a regular basis to take into account changes in the client’s personal situation, the economic environment and legislation. For a full discussion on how to make maximum use of the tax deductibility of contributions, see ¶4-210 to ¶4-275.

¶15-048 Non-concessional contributions

Non-concessional contributions are not taxed when contributed to the fund and are added to the tax-free component of a superannuation balance. These contributions are subject to the non-concessional contribution cap. The following are generally classified as non-concessional contributions: • personal contributions for which no tax deduction is claimed • the tax-free portion of an overseas superannuation transfer • spouse contributions • excess concessional contributions (that are not released from the fund back to the client). Contributions that are also tax-free but not included in the definition of a non-concessional contribution for cap purposes include: • up to $1,565,000 over a lifetime of contributions sourced from the disposal of qualifying small business assets which are contributed under the CGT cap (see ¶2-300 to ¶2-360) • contributions sourced from a personal injury payment under structured settlement rules • government co-contributions • the refund of contributions tax for low income earners (low income superannuation tax offset) • up to $300,000 per person of downsizer contributions from the sale of one qualifying home (¶15-198). Non-concessional contributions are made from after-tax money and do not qualify for any tax concessions (except the spouse offset or government co-contribution, where applicable). The wealth accumulation plans of a client will benefit from these contributions where the tax rate on earnings inside superannuation (ie 15%) is lower than the marginal tax rate on earnings outside superannuation. When recommending non-concessional contributions, financial planners should ensure the client does not exceed the non-concessional contribution cap. For 2020/21, this is set at a maximum limit of $100,000 per financial year. A bring forward rule allowing contributions up to $300,000 in a single year is allowed for clients under age 65 (as at 1 July for that year) who have less than $1.4m in superannuation (a pro-rated amount is allowed if balance is between $1.4m and $1.6m), although the client is then limited to a total of $300,000 contributions in the three-year period covering that financial year and the following two years.

Note Legislative change has been proposed to increase the age limit on triggering the bring forward rule from age 65 to age 67. This is in line with the changes in age at which the work test is required. Treasury Laws Amendment (More Flexible Superannuation) Bill 2020 has been introduced into Parliament but at the time of writing has not been passed as law.

The cap operates on a “use it or lose it” basis, that is, if a cap is not fully utilised in any year the unused amount cannot be credited to a future year (except during the relevant three-year period if the bring forward rule has been triggered). Unless the excess non-concessional contributions plus associated earnings are released from superannuation, excess tax applies at 45% plus Medicare levy (and other levies as applicable), thereby significantly reducing the effectiveness of the strategy to accumulate wealth. If released, the associated earnings will be added to taxable income and taxed at marginal tax rates. Non-concessional contributions strategies Tax deductions are not available on non-concessional contributions, so the net amount available to invest is the same for superannuation and non-superannuation investment options. Only if the client is eligible for the co-contribution or a tax offset for spouse contributions will after-tax super contributions provide an

up-front advantage compared to non-superannuation. Despite this equalisation, there are various strategies available that effectively utilise non-concessional contributions to the benefit of the clients. The main objectives are to reduce the clients’ potential tax payable on benefits withdrawn before age 60 and/or the ability to generate a lower after-tax return inside superannuation due to the lower tax rate on earnings (compared to the client’s marginal tax rate). These strategies are: • recontribution — ¶15-180 • spouse contributions — ¶15-190 • government co-contribution — ¶15-195.

¶15-050 Concessional contributions Concessional contributions are contributions which are assessable for “contributions tax” in the hands of the superannuation fund trustee. While this tax is referred to as contributions tax, it is not really a separate tax. The concessional contributions are simply added to the taxable income of the fund and the 15% earnings tax applies. Concessional contributions include the following: • all deductible personal contributions • employer contributions (eg SG, voluntary employer contributions and salary sacrifice) • the taxable component (over $1m) of an eligible employment termination payment contributed to super before 1 July 2012 (cannot be rolled over from 1 July 2012) • distributions from certain fund reserves to a member’s account.

Note If a super fund is not notified of the members’ tax file number (TFN) with respect to a concessional contribution, tax at the excess rate (ie 30% plus Medicare levy) is payable on the whole contribution. This tax can be claimed back if the TFN is supplied within four years.

Annual concessional contribution cap The concessional contribution cap has been significantly reduced over time. The concessional contribution cap for 2020/21 is set at $25,000 (indexed) for everyone. The cap applies per individual, with all concessional contributions made in the financial year counted in the cap, including all contributions made by the employer. For example, a 40-year-old employee earning $120,000 would have SG contributions of $11,400 contributed on their behalf in 2020/21 and can salary sacrifice or claim personal deductions up to an additional $13,600 before exceeding the cap.

Note Clients with total superannuation balances below $500,000 on 30 June of previous financial year, are able to carry forward any unused concessional contribution cap (starting from the 2017/18 financial year) for up to five years. This can allow higher contributions in later years.

Higher contribution tax for people earning over $250,000 Higher tax applies to concessional contributions for a person who has income over $250,000 (from 1 July 2012 to 30 June 2017 the income threshold was $300,000). For this purpose, income is defined as adjusted taxable income plus any concessional contributions within the concessional contribution cap. If the income threshold is exceeded, an additional 15% tax will be levied on the concessional contributions (in addition to the normal 15% contributions tax). The additional tax applies to the portion of contributions that take income over the $250,000 threshold, assuming the contributions are added last. This is called the Division 293 tax and means the impacted contributions are taxed at 30% instead of the standard 15%. Excess concessional contributions charge In the same way as for non-concessional contributions, financial planners should ensure clients do not exceed the concessional contribution cap. If a client exceeds the concessional contribution cap, the client’s tax return for the relevant year is adjusted to include the excess contributions as taxable income and tax applies at the marginal tax rate plus Medicare levy (and any other levies applicable for that year) less allowance for the 15% tax already paid by the fund. An interest penalty (excess concessional contributions charge) will apply to account for the delay between the year of contribution being made and the assessment of the excess amount. The client can elect to withdraw up to 85% of excess concessional contributions (applies since 1 July 2013) which will avoid these amounts also being counted against the non-concessional contribution cap. If the excess contribution is used to pay for insurance inside superannuation and the full tax deduction is refunded to the client by the trustee, this may not result in a comparative disadvantage for the client. Personal deductible contributions Before 1 July 2017, only self-employed persons or those who earned less than 10% of assessable income (plus reportable fringe benefits) from employment as an employee could claim a tax deduction for their contributions. These contributions were included in the concessional contribution cap. Under current rules, everyone who is eligible to make a contribution and is under age 75 can choose to claim a tax deduction for personal contributions. Prior to 1 July 2020, a work test was required to be met from age 65 to make a contribution (¶4-205), but amendments to SIS Regulations have increased the age at which the work test is required to age 67. In addition, if clients aged 67 to < 75 (or in 2019/20 from 65 to < 75) have a total superannuation balance less than $300,000, in the first year after retirement they are exempt from meeting the work test requirements to make a contribution. The increase to age 67 is aligning superannuation rules to the eligibility age for the age pension which is increasing to age 67. The ability to claim personal deductions allows employees who have superannuation guarantee contributions paid by their employer to choose to claim tax deductions for personal contributions instead of salary sacrifice. They could also use both options, but are subject overall to the one concessional contributions cap.

Note If under age 18, a deduction can only be claimed if earning employment or business income.

How may these tax deductions be best utilised? The rules for 2020/21 are best illustrated by way of an example. Example

Karen is 53 years old and works as a graphic designer. She is self-employed, earning $70,000 pa. She is five years away from her planned retirement age of 58 and wishes to rearrange her financial situation with a view to maximising her retirement assets. Karen has an existing residential investment property worth $250,000 and $60,000 in a cash management trust. Karen believes that a mix of investments is a better foundation for retirement than continuing to hold the investment property, so she has decided to sell the property. This creates a taxable capital gain of $25,000 (after applying the 50% discount). Karen can choose to make personal superannuation contributions and claim a tax deduction on contributions up to $25,000 for the 2020/21 financial year as she has no other employer contributions. Karen can use the tax deduction to minimise her CGT liability. On your advice, she decides to make a concessional superannuation contribution of $25,000 to obtain a tax deduction of $25,000 to offset the capital gain.

Deductible contribution ($)

No deductible contribution ($)

Salary income

70,000

70,000

Taxable capital gain

25,000

25,000

(25,000)

Nil

Taxable income

70,000

95,000

Tax and Medicare

15,697

24,547

Low income tax offset & low and middle income tax offset

1,080

930

Contributions tax

3,750

Nil

$18,367

$23,617

Tax deduction

Total tax and Medicare payable*

* Using 2020/21 PAYG tax and Medicare rates assuming Karen is not liable for the Medicare levy surcharge.

The overall tax saving in this example is $5,250 which can be used to increase the level of her savings. Karen could also make a non-concessional contribution or invest the money outside superannuation and make further deductible contributions in coming years.

Clients should be advised to seek taxation advice to determine the optimum amount to claim as a tax deduction. This should consider access to the tax-free threshold and other eligible offsets. The tax deduction cannot be higher than the level of taxable income.

¶15-100 Salary sacrifice contributions Prior to 1 July 2017, employees were generally unable to claim a tax deduction for contributions to a superannuation fund. Instead employees needed to arrange salary sacrifice through their employer to make tax-effective superannuation contributions and boost the levels of savings. Employees under age 75 are now able to choose either option (provided salary sacrifice is offered by their employer). The overall taxation impact is the same, but timing of the deductions varies. Salary sacrifice allows the contributions to be made from pre-tax salary. Claiming a personal deduction requires the contributions to be made potentially from post-tax money with the tax refunded through the tax return at the end of the financial year. The discipline of salary sacrifice may encourage some employees to continue with a savings plan however, making personal contributions and claiming a tax deduction at the end of the financial year may allow greater flexibility and control over the strategy. Who benefits from this strategy? This strategy currently works best for clients who: • have an effective marginal tax rate higher than 15%, and • have surplus salary income and wish to accelerate the building up of superannuation assets through

regular contributions during the year. Example Sarah has an existing salary package of $180,000. She has just been given a $7,000 pay increase for 2020/21 with 9.50% SG paid on the full $187,000. She is thinking of using the pay increase to boost her superannuation because she has fallen below her target funding level. She is now in the top marginal tax rate and her employer allows her to choose between a salary sacrifice arrangement or after-tax contributions into superannuation. Which is the more tax-effective option for Sarah? It is important to note that both the salary and the superannuation contributions are tax deductible to the employer, so each option presents the same economic cost to the employer. If Sarah salary sacrifices to superannuation, the total contributions ($17,765 SG plus $7,000 salary sacrifice for the pay rise) do not exceed the concessional contribution cap ($25,000).

Option 1 Take additional salary in cash and make a nonconcessional contribution ($)

Option 2 Employer super contribution (salary sacrifice) ($)

Payment by employer

7,000

7,000

Less income tax*

3,290

N/A

Nil

1,050

$3,710

$5,950

Less contributions tax Net amount added to fund

* Using 2020/21 PAYG tax and Medicare rates and assumes she is not liable for the Medicare levy surcharge.

Sarah has more money invested in the fund if she chooses a salary sacrifice arrangement. While it may not sound like a great deal of savings now, it can make an incredible difference over time when compound interest is taken into account.

Other planning issues Salary sacrifice is also beneficial to clients who find it difficult to establish a regular savings habit. Having superannuation debited from salary is convenient and provides such clients with a disciplined approach to saving. It is first necessary to establish whether the employer will allow the employee to salary sacrifice. If this is not the case, an alternative investment strategy needs to be set in place, including the client could choose to make personal contributions (perhaps through a regular direct debit) and claim a tax deduction in their tax return. For clients who are on high incomes at a relatively young age, the merits of contributing to superannuation (and the tax benefits) may need to be weighed against the legislative risk associated with superannuation and preservation rules. A 30-year-old faces substantially higher legislative risk than a 50year-old. The low levels for the concessional contribution cap also limit the benefit of this strategy. The Australian Taxation Office (ATO) issued Taxation Ruling TR 2001/10 in relation to salary sacrifice arrangements. For salary sacrifice to be effective, the arrangement should be a prospective one, where salary is sacrificed before the employee is presently entitled to it. It is important to ensure that procedures adopted by the employer do not amount to gross salary being paid to the employee which is then merely redirected by the employee into superannuation. If this occurs, the arrangement is not effective and the contribution will be taxed as income in the hands of the employee. Particular care should be taken with bonus payments. If bonus payments are to be designated as salary sacrifice contributions, clients should nominate this before they become entitled to the bonus. Problems may also arise with exceeding the concessional contribution cap. As the amount of the bonus will be unknown in advance, the instructions to employers need to be given carefully. For example, instructions may be given to salary sacrifice the amount of any bonus that is within the concessional contribution cap

for the year. To ensure that salary sacrifice arrangements are prospective it is wise to document them in full. Ideally salary sacrifice amounts should be nominated at the start of each financial year or at the start of a new job.

¶15-110 Transitioning to retirement Individuals have the option of accessing their superannuation benefits in the form of a non-commutable income stream while still working. To do this: • the individual must have reached preservation age, and • the benefit must be taken as a non-commutable pension. There is no work test and no restrictions on how much of a person’s benefit can be used to start an income stream under these rules. When a further condition of release is met, such as retirement, the trustee can be notified of this event so that the cashing restriction can be removed and the income stream can be commuted or accessed for lump sum withdrawals.

Note From 1 July 2017, the amount that can be rolled over to an income stream is limited by the transfer balance cap (the general cap has not yet indexed from the original level and for 2020/21 is $1.6m per person) but this does not include pensions paid under transition to retirement as they are not deemed to be “retirement phase” income streams.

Generally, clients using this strategy start a non-commutable account-based pension (often referred to as a transition to retirement or TTR pension). The normal minimum payments apply (4% under age 65) but the maximum payment in any financial year is limited to 10% of the 1 July balance (¶16-155) or starting balance in the first year. Despite being an income stream, from 1 July 2017, a transition to retirement income stream is not deemed to be a retirement phase income stream so the earnings are not tax-free. From 1 July 2017, the earnings are taxed at 15% in the superannuation fund. A non-commutable account-based pension can only be commuted: • to roll back to accumulation phase (eg if the income stream is no longer required), or • to roll-over to another non-commutable income stream. Example Gary is aged 60 and working full time with a salary of $60,000. His accumulated superannuation is $340,000, comprising all taxable component. Gary’s employer offers him the opportunity to reduce his hours and work part time on a pro-rata salary of $38,000. The idea of working fewer hours appeals to Gary, provided he can continue to fund his living expenses of $45,000 pa. Can he achieve this? As he has reached preservation age, Gary can convert his existing superannuation benefits into a non-commutable account-based pension. Gary can choose to receive an annual income between $13,600 (4% of balance) and $34,000 (10% of balance) in 2020/21. He elects to draw $16,000. Note that in practice, if the income stream is started part-way through a financial year the minimum income can be pro-rated for that year but the maximum is not pro-rated.

Option 1: Continue working full time ($)

Option 2: Part-time work with income stream

($) Salary income

60,000

38,000

–

16,000

60,000

54,000

(12,247)

(10,177)

1,180

1,270

Total tax payable*

(11,067)

(8,907)

Net income after tax

$48,933

$45,093

Account-based pension income Total income Less income tax (incl Medicare) Plus low income tax offset & low and medium income tax offset

* Using 2020/21 PAYG tax and Medicare rates.

Gary can maintain his current level of expenditure by supplementing his reduced salary income with income from his noncommutable account-based pension. This will, however, start to diminish his retirement savings.

Salary sacrifice and non-commutable pension strategy While the transitional retirement condition of release was originally intended to be used by people working reduced hours, it became a more common strategy for clients still working full time. These clients can choose to start a non-commutable account-based pension in conjunction with a salary sacrifice strategy.

Note The 1 July 2017 changes that tax the earnings for pensions paid under the transition to retirement (TTR) rules at 15% and lower contribution caps, have significantly reduced the attractiveness of this strategy for clients who do not need to generate additional income.

Clients may still wish to start a non-commutable income stream to enable employment income to be salary sacrificed into super if: • taxable pension income for a client aged between 55 and 60 is eligible for a 15% tax offset and for a client aged 60 and over is tax-free, whereas salary and wage income is fully taxable and the net amount withdrawn is less than the amount contributed • the client wishes to increase cash flow to repay debts or achieve other objectives. The ATO has confirmed that the general anti-avoidance provisions in Pt IVA of the Income Tax Assessment Act 1936 (ITAA36) would not generally apply where a person was commencing a noncommutable pension and making salary sacrifice contributions to super (ATO media release, 17 November 2005). However, each situation needs to be reviewed individually to ensure the Pt IVA provisions do not apply. Refer to ¶16-610 for an example of how the transition to retirement strategy can impact the retirement savings for clients still working full time. Clients should be referred to a tax adviser to determine the optimal levels of salary sacrifice and pension income. Care should also be taken not to exceed the concessional contribution cap as this will reduce the tax effectiveness of the strategy. Clients may similarly benefit from this strategy by making concessional contributions to superannuation and claiming the tax deduction instead of using salary sacrifice.

¶15-180 Re-contribution strategy and maximising the tax-free component Two strategies may change the taxable and tax-free component proportions in the fund by increasing the tax-free component. These strategies can reduce tax payable on income streams paid before age 60 or on death benefits paid to a non-financial dependant, and may also provide protection against the possibility of changes to taxation rules in the future. These strategies are: • adding further non-concessional contributions into superannuation before making a withdrawal to increase the total proportion that is tax-free, or • using a recontribution strategy, whereby a tax-free amount is withdrawn from superannuation and then recontributed as a non-concessional contribution before acquiring an income stream. See sections ¶4-420 and ¶4-425 for tax on superannuation benefits to a member and on death benefits.

Note The ATO accepts that recontribution strategies may not breach Pt IVA anti-avoidance provisions in circumstances where retirement benefits are obtained. Individual circumstances should be assessed to ensure that Pt IVA provisions do not apply.

Example Maximise tax-free proportions before age 60 Bert is age 57 and withdraws $100,000 from his super fund on 15 August 2020. On that date his total benefit is $500,000 of which his tax-free component is $50,000. This component is 10% of his total benefit of $500,000 so his withdrawal proportion will be: – tax-free (10%) $10,000 – taxable (90%) $90,000. Assuming Bert has already used his full low rate cap ($215,000 for 2020/21), he will pay tax of $15,300 on the withdrawal (ie $90,000 × 17%), including Medicare levy. If, before making the withdrawal, Bert makes a non-concessional contribution of $50,000 (does not exceed his available cap), this will change the split between taxable and tax-free components and reduce lump sum tax. Making a $50,000 non-concessional contribution would increase the super benefit to $550,000, of which $100,000 would be tax-free. Thus, a future payment would be 18.18% ($100,000/$550,000) tax-free, changing the tax situation on a $100,000 lump sum withdrawal to: – tax-free (18.18%) $18,180 – taxable (81.82%) $81,820. Assuming Bert has already used his full low rate cap ($215,000 for 2020/21), he will pay tax of $13,909 on the withdrawal (ie $81,820 × 17%), including Medicare levy. The non-concessional contribution has reduced Bert’s tax by $1,391. However, if he is over age 60 the full amount would be tax-free regardless of the component split.

Example Re-contribution strategy Stephen, 57, has $400,000 in superannuation which is all taxable component. He met a full condition of release and commenced an account-based pension on 1 July 2020. He withdraws $50,000 income from his pension in the first year. His taxation situation (assuming no other taxable income) is outlined in the table below. In option 1, he rolls over the full balance (as all taxable component) to start the pension. In option 2, he cashes out $215,000 (assuming he has not previously used any of his low rate cap allowing the withdrawal to be tax-free) and recontributes this amount as a non-concessional contribution before starting the income stream. This assumes he does not exceed his non-concessional contribution cap and was able to trigger the bring forward rule.

Option 1: All taxable component

$  Income from the pension

50,000

Less: tax-free amount Taxable income from pension Tax on taxable income

— 50,000 7,797

Less: 15% offset on pension

(7,500)

Less: low income offset & low and medium income tax offset

(1,330)

Plus: Medicare levy payable

1,000

Tax payable

1,000

Option 2: Cash out $215,000, recontribute as non-concessional contribution using bring forward rule and then start account-based pension so tax-free component is 53.75% ($215,000/$400,000) $  Income from the pension

50,000

Less: tax-free amount 53.75%

26,875

Taxable income from pension

23,125

Tax on taxable income Less: 15% offset on pension Less: low income offset & low and medium income tax offset

936 (3,563) (700)

Plus: Medicare levy payable

Nil

Tax payable

Nil

Note: excess offsets cannot be used to pay Medicare levy. Stephen would save $1,000 pa in tax on his income stream in the first year. However, he might also consider delaying retirement until age 60 as no tax would be payable on the pension after age 60.

Who benefits from this strategy? In general, the re-contribution strategy works best for clients who: • are under age 60 who plan to start an income stream before reaching age 60, and • have not already made withdrawals of taxable component that have used up the low rate cap ($215,000 for 2020/21), and • can recontribute the money as non-concessional contributions without creating an excess contribution, and • are in the higher income tax brackets — as the strategy is designed to minimise the client’s taxable income, or • have a spouse — in this case money may be recontributed in the spouse’s name (provided they are eligible to receive or make a contribution and have not used up their non-concessional contribution cap). Can your client recontribute?

Matters that must be resolved before such a strategy can be implemented include: • the client must be able to access a lump sum benefit which means the client must be able to satisfy a condition of release (¶15-400) • the client must be eligible to contribute to superannuation (¶4-205) • the client’s available non-concessional contribution cap should be calculated to avoid an excess contribution.

¶15-190 Spouse contributions Spouse contributions are an ideal planning tool as financial planners frequently meet couples where one of the partners has not worked for a long period, for example they stayed at home to raise the children or care for other family members. The immediate benefit of a spouse contribution applies where the contributing spouse is eligible for a tax offset on the contribution. This applies if: • both partners were Australian residents at the time the contributions were made • the contributing spouse cannot claim for the contributions under ITAA97 s 290-60, and • the spouse’s assessable income plus reportable fringe benefits for the financial year is less than $40,000 (ITAA97 s 290-230(1), (2)) — this increased from $13,800 on 1 July 2017. The contributing spouse is not subject to a work or age test. If the spouse for whom the contributions are made is under age 67 (increased from age 65 to 67 from 1 July 2020), the spouse contributions may be accepted by the superannuation fund or RSA without restrictions. If the receiving spouse is between age 67 and 74, he/she must satisfy a work test, and if the receiving spouse is age 75 or over, the contributions cannot be accepted (¶4-275).

Note The ages for spouse contributions increased and brought into line with the new rules for eligibility to make a personal contribution from 1 July 2020. Spouse contributions can now be made until the receiving spouse reaches age 75, but a work test may apply from age 67 unless eligible for an exemption in the first year of retirement.

Tax relief is available as a tax offset. The offset is available on up to $3,000 of superannuation contributions made by a contributing spouse on behalf of their low income or non-working spouse. The offset rate is 18% of the spouse contributions made but is subject to a maximum offset of $540. For 2020/21, the full 18% offset is available if the recipient spouse’s assessable income plus reportable fringe benefits is $37,000 or less for the financial year (was set at $10,800 applicable before 1 July 2017). The available offset reduces if the recipient spouse earns more than this amount, cutting out when the recipient spouse’s assessable income plus reportable fringe benefits exceeds $40,000 (was set at $13,800 applicable before 1 July 2017). The limit of $3,000 is reduced by $1 for each $1 that the recipient spouse’s income exceeds $37,000. Example Donna works casually as a secretary and has assessable income of $8,000. Her husband, Hugo, plans to contribute $1,000 to a superannuation fund on Donna’s behalf. The maximum offset that Hugo can claim on these contributions is $180 ($1,000 × 18%).

Eligible spouse contributions are classified as non-concessional contributions (¶15-048) and are added to the tax-free component. Earnings on the eligible spouse contributions will form part of the spouse’s taxable component. The following example illustrates why spouse contributions are an ideal pre-retirement planning tool. Example Michelle, aged 63, has not worked for the last 10 years and has very limited superannuation benefits of her own. Her assessable income is $10,000. She recently married Michael, 72, who has significant assets in superannuation (he already has an accountbased pension) as well as non-superannuation assets. Michael is not able to make a personal contribution to superannuation due to his age and retired status. To reduce their overall tax liability on non-superannuation income, Michael makes a $100,000 contribution on behalf of Michelle from his non-superannuation assets. Michael will be entitled to the full offset of $540 against his tax payable.

Making spouse contributions is an effective option to help build superannuation savings for both members of a couple. This can help with retirement planning and may provide protection against future tax changes. Spouse contributions also allow a couple to maximise the total that can be rolled over to income streams, now that each partner is subject to a transfer balance cap. This is a per person limit, so it is effectively doubled for a couple if they both have superannuation savings. In the example above, if Michael makes contributions to build Michelle’s superannuation, she will be able to transfer her superannuation benefits to a superannuation pension when she meets a condition of release. The earnings supporting the pension are tax-free and the pension payments are exempt as Michelle is over 60. Michelle and Michael are now able to run two income stream products. Using the non-concessional contribution caps Non-concessional contributions to superannuation are limited by the non-concessional contribution cap (¶4-240). If one member of a couple has already used up this limit, the couple may gain an overall tax advantage by making either a spouse contribution or personal contribution for the other spouse to utilise that spouse’s limit. The spouse contribution received counts in that person’s non-concessional contribution cap.

¶15-192 Spouse contribution splitting Members of most super funds can split superannuation contributions each year with their spouse (legal or de-facto spouse, including same sex). Only concessional contributions (including SG and salary sacrifice) from the accumulation phase can split with a spouse. The superannuation fund must choose to offer this option as a feature within the fund.

Note Members of defined benefit super funds will not be able to split contributions that fund their defined benefit. However, they may be able to split contributions that fund a separate accumulation benefit.

Eligible members have one opportunity each financial year to split contributions made during the previous financial year. They can choose to split the lesser of: • 85% of the total concessional contributions made, and • the concessional cap for the year. All contributions that are subject to a split will be transferred to the receiving spouse’s account as taxable

component. All contributions are measured against the original spouse’s concessional contribution cap, not the receiving spouse’s cap. Amounts that cannot be split with a member’s spouse include: • existing superannuation benefits • amounts that have been rolled over into the member’s account • non-concessional contributions • employment termination payments, and • lump sum payments from a foreign superannuation fund. A splitting application will be invalid where the receiving spouse is: • aged 65 years or more, or • between preservation age (between age 55 and 60 depending on date of birth) and age 64, and satisfies the “retirement” condition of release at the time of the application to split. This means that members are unable to split contributions with a spouse who has met a retirement condition of release. Superannuation splitting may provide the following advantages: • allow each spouse to fully utilise their low rate thresholds thereby doubling the amount that can be withdrawn by a couple (compared to one person) as a tax-free lump sum before age 60 (subject to preservation) • help to equalise savings in each partner’s name to maximise the use of each person’s transfer balance cap • where contributions are split to a younger spouse (under Age/Service pension age), this may reduce benefits that would otherwise be assessed when the older member of a couple reaches Age/Service Pension age and applies for a Centrelink/DVA payment • if legislation is changed in future to apply tax on earnings or benefits in the pension phase, this measure may help spread the total account balance across each partner to potentially minimise overall tax. Even if taxation benefits are not substantial, splitting may have advantages for estate planning or issues of control and access to benefits for each spouse.

¶15-195 Government co-contribution To be eligible for the government superannuation co-contribution, certain requirements need to be met. Broadly, the client needs to: • have made or make personal contributions to their superannuation fund • have total income below the income threshold of $54,837 for the 2020/21 financial year. Income is defined as assessable income plus reportable fringe benefits plus reportable superannuation contributions • have total superannuation balance less than the transfer balance cap (the general cap is $1.6m in 2020/21) • earn more than 10% of total income from employment or self-employment

• not hold a temporary work visa • be under age 71 at the end of the financial year • be a permanent resident of Australia. The co-contribution applies at 50 cents for each eligible $1 contributed. The maximum co-contribution is reduced by 3.333 cents for each $1 of total income over $39,837. The superannuation co-contribution phases out completely where assessable income (plus reportable fringe benefits plus reportable superannuation contributions) exceeds $54,837 for 2020/21. Provided the client is entitled to receive the superannuation co-contribution, the minimum amount payable is $20. The formula for calculating the maximum superannuation co-contribution amount in 2020/21 is: Amount to contribute to gain maximum cocontribution:

$1,000 − ([(total assessable income + reportable fringe benefits + reportable super contributions) − $39,837] × 0.03333)

Eligible co-contribution

Amount to contribute × 50%

Example Jane earns a taxable income of $43,000, on which an SG payment is made by her employer. She has a total superannuation balance of $200,000. Jane receives no reportable fringe benefits and decides, on your advice, to contribute $1,000 as a nonconcessional contribution into her superannuation fund in 2020/21. Only this $1,000 non-concessional contribution can be eligible for the co-contribution. Using the co-contribution formula above, the maximum government co-contribution she is eligible to receive is: $1,000 − ([($43,000 + 0) − $39,837] × 0.03333) = $894.58 × 50% = $447.29 Jane will need to contribute at least $894.58 as an after-tax contribution to be eligible for the $447.29 co-contribution. If she contributes a lower amount, the eligible co-contribution is reduced accordingly.

The superannuation co-contribution: • is preserved in the fund • is not included in the client’s tax return • will not be subject to any taxation when initially paid to the fund • is included in the tax-free component • is not counted as part of the non-concessional contribution cap. The co-contribution payable is calculated by the ATO via the tax return process with data matching from the lodgment of superannuation fund returns. It is a worthwhile strategy for low to middle income earners and is particularly effective when combined with a further spouse contribution or salary sacrifice to build savings.

¶15-198 Downsizer contributions Many clients who are retiring may consider selling their home and relocating to either move to a smaller and more manageable home or to release equity to top-up income sources. New superannuation rules commenced on 1 July 2018 which introduced a new superannuation contribution category — downsizer contributions (¶4-222). If a principal residence (home) is sold, each eligible owner may be able to contribute up to $300,000 into superannuation. The eligibility rules are: • must be at least age 65 at time of contribution but no upper age limit • contribution must be made within 90 days of settlement (ie change of ownership date)

• must notify the fund trustee of this choice using the required ATO form at the time of making the contribution • cannot have already used this option for another home • can only use sale proceeds from a home located in Australia • the home must have been owned for at least 10 years and qualify for the main residence CGT exemption (full or partial). There is no upper age limit to be eligible to contribute, so clients age 67 or older can use this contribution option which may allow clients not otherwise eligible, to get more money into superannuation. Clients do not need to meet a work test requirement to make the contribution. Example Josie and Frank retired eight years ago. Now in their late 70s they are finding the maintenance of the home difficult to manage. They sell the home for $1.2m and use $500,000 to buy a unit in a retirement village. Josie and Frank each contribute $300,000 into superannuation using the downsizer contribution rules and then start account-based pensions to top-up income. The remaining money is invested into a term deposit.

CGT AND SMALL BUSINESS ¶15-200 Small business and superannuation There are four CGT concessions available to small business owners (see ¶2-335 for eligibility criteria): (1) 15-year asset exemption — if an asset is owned by an entity for more than 15 years, it may be exempt from CGT. • if the entity was an individual, he/she must be over 55 and must retire or be permanently incapacitated. • if the entity was a company, the entity must have a controlling individual who is over age 55. (2) 50% reduction for active assets. • active assets that do not meet the 15-year exemption may qualify for the 50% active asset exemption so only 50% of the gain is taxable. • if the individual CGT discount of 50% has already been granted then the remaining 50% will receive a further 50% exemption (ie 25% remains taxable). • this exemption applies before the small business retirement exemption or roll-over concession (but is an optional step). (3) Retirement exemption. • this exemption of up to $500,000 (lifetime limit) per individual is available if the conditions outlined below are met: – the amount chosen to be disregarded (the exempt amount) is specified in writing, and – for an individual under age 55, the individual contributes an amount equal to the exempt amount to a complying superannuation fund or retirement savings account (RSA) when making the choice (if the CGT event is J2, J5 or J6) or in other cases, at the later of receiving the proceeds from the event or making the choice. Where the proceeds of the sale of a small business asset meet the conditions of either the 15-year exemption or the small business retirement exemption, they can be contributed to superannuation

and can be elected to be assessed against the small business CGT cap ($1.565m lifetime limit for 2020/21) instead of the non-concessional contribution cap. The contribution must be made no later than the day the client is required to lodge their tax return for the financial year in which the sale occurred or 30 days after the day the client received the capital proceeds. (4) Small business asset roll-over relief. • this option defers the payment of CGT on a business asset if the proceeds are used to buy a new business asset. CGT is deferred until the sale of the new asset.

¶15-210 Small business retirement issues The complexities and the interrelationship between small business, CGT and retirement have resulted in this area requiring significant planning. The aim of the government in introducing the small business CGT concessions was in recognition that most small business owners spend their time and resources in building up the value of their business. The result is that they have a significant asset (their business) but no money to fund their retirement. The changes allow small business owners to reinvest back in their own businesses with the view of realising these assets to fund retirement. This reflects the fact that a small business often does not have the cash flow to build up superannuation assets for the owners and also build up the assets of the business. Issues to be considered in the planning stages include the following: • Business owners need to review the structures under which they currently operate to qualify for the CGT concessions where possible. • The main relief provision encompasses the 15-year rule which may mean owners stay in a business longer than their preferred retirement age. • Be aware of the danger of overcapitalising on a business. While the CGT provisions provide some relief, owners might not be able to realise the full value of their business if it is overcapitalised. • Ensure there is a sound succession plan in place to maximise the value of the business on the key person’s exit. • Be aware of the business cycle and when you plan to sell an asset — the 15-year rule may in fact work against you. • Business owners should also build wealth outside of their business. Not making use of superannuation and reinvesting in the business can be a case of putting all your eggs in one basket. This is exactly what financial planners advise clients not to do. • Investing in superannuation on a regular basis may provide business owners with some bankruptcy protection. Example Case study Paul and Dionne Smith are married as well as partners in an accounting and financial planning firm. Paul is aged 55 and Dionne is aged 52. The Smiths initially purchased an existing accounting business in 2005 for $500,000. Since that time, they have built the business into a large and profitable operation and would now like to sell. After negotiation, Paul and Dionne have agreed to sell the business for $2m. Paul and Dionne currently have personal assets worth $1.9m consisting of: • family home — $800,000 • cars — $60,000 • investment unit — $250,000

• shares and managed funds — $250,000 • superannuation — $540,000. After the sale, Paul and Dionne would like to retire. Question Are the Smiths entitled to claim any of the small business CGT exemption on the sale of their business and, if so, how much tax will they pay on the $1.5m of capital gains they will realise? Each CGT concession stakeholder needs to be looked at individually. For simplicity, we will look at Paul’s situation and apply this equally to Dionne’s. Step 1: Ascertain if the basic conditions for the small business concessions are met (a) Is the combined net CGT asset value of Paul, his CGT affiliates and all entities connected with him worth a total of less than $6m? (b) Do the assets satisfy the active asset test? To satisfy this test, the assets must be: • active assets of the business or of a related entity or affiliate’s business at the time of sale (or at cessation of business, if business ceased within 12 months of sale) • active for at least 50% of the time that they were held, or 7.5 years if held longer than 15 years. If the business was set up as a company or trust, those shares or rights would be considered active assets if at least 80% of the assets of that company or trust were active assets. (c) Does the business have a significant individual and is the individual claiming the exemption as a “CGT concession stakeholder”, that is, the significant individual or their spouse? If the answers are “yes” to all of the above, the basic conditions for the concessions have been met. (a) Assuming Paul and Dionne are not connected with any other companies or trusts, the CGT assets that count toward the $6m threshold are: • the total value of CGT assets of the partnership — $2m • Paul’s half of the investment unit and shares — $250,000 ($125,000 × 2). The total value of Paul’s CGT assets is $2.25m, which is below the $6m CGT asset threshold. We do not include Dionne’s half of the shares or unit in the total value as, even though she is a CGT affiliate of Paul, she is not holding these assets to carry on a business with Paul. (b) The assets being sold in this example (property and goodwill) are active assets at the time of sale and were active for at least 50% of the time since acquisition. (c) As a partner in a partnership, Paul is treated as an individual, eligible for these concessions. Paul therefore satisfies all the basic criteria of the small business exemptions. The position for Dionne is exactly the same, as she is an equal partner with Paul. If she was only a 10% partner, she would still be eligible as Dionne would be the spouse of a significant individual and therefore a CGT concession stakeholder. Step 2: Apply the relevant exemptions in the required order The Smiths are not eligible to claim the 15-year exemption as they have held the assets for less than 15 years. However, if they had held the assets for 15 years, only Paul could claim the exemption as Dionne does not satisfy the additional prerequisites of being over 55 or permanently incapacitated.

50% individual exemption Paul’s nominal gain

= $750,000 ($1.5m − $750,000)

50% exemption

= $750,000 × 0.5

Assessable gain

= $375,000

50% active asset exemption Assessable gain

= $375,000

50% exemption

= $375,000 × 0.5

Assessable gain

= $187,500

100% retirement exemption Assessable gain

= $187,500

Offset ($500,000 limit) = ($187,500) Assessable gain

= Nil

The same calculations apply to Dionne for her half of the business. As Dionne is under 55, she could have to roll her $187,500 amount over to a complying superannuation fund. Paul, being over 55, could take the retirement exemption amount as cash if desired, or contribute it to superannuation as a preserved amount. As a result of using these exemptions, Paul and Dionne’s CGT liability on the sale of the active assets of their small business has been reduced to nil. Please note if the business had been set up as a company or trust, the concessions may still be available but the treatment and end result may differ. The $187,500 claimed under the CGT retirement exemption can be contributed to superannuation using the CGT small business cap. Paul and Dionne could choose not to claim the active asset discount. In this case, they would still receive the full gain tax-free but the amount that each could contribute to superannuation using the CGT small business cap would be doubled (subject to the $500,000 CGT cap each).

Note The limits on non-concessional contributions may increase the desire to maximise the use of the small business CGT cap. Amounts contributed under the CGT cap do not count towards the nonconcessional contribution cap. In the example above, by not claiming the active asset discount, Paul and Dionne can use more of the CGT cap and leave more of the non-concessional contribution cap for other amounts they wish to contribute to superannuation.

PRESERVATION ¶15-400 Preservation rules Many of the taxation benefits associated with investing in superannuation have been discussed. However, in return for these taxation benefits clients must be prepared to give up access to funds invested in this concessionally taxed area. The taxation regime of superannuation benefits encourages people to take income streams. Preservation rules should be taken into consideration before implementing any of the strategies discussed here. This is to ensure that: • clients fully understand that access to their funds is subject to government restrictions • clients take preservation issues into account when formulating and deciding on a suitable financial strategy to meet their personal needs • the financial planner makes sufficient provision for the accumulation of assets outside superannuation to meet clients’ financial liquidity needs. All contributions made by or on behalf of a member to a regulated superannuation fund from 1 July 1999 and all earnings from that date are preserved, subject to grandfathering arrangements for the member’s non-preserved benefits as at 1 July 1999. The member’s restricted non-preserved and unrestricted non-preserved benefit will not be indexed. This means that over time the value of this amount relative to the preserved amount will generally decline. The superannuation preservation age has increased for anyone born after 30 June 1960 on a gradual scale, with the preservation age of 60 applying to anyone born after 30 June 1964 (¶4-400).

Conditions of release Common conditions of release where there are no restrictions on the member cashing the benefit are: • retirement of the member after reaching their preservation age • member attaining the age of 65. Transitioning to retirement A limited condition of release which allows members who have reached their preservation age, but who are still working either full time or part time, to access their superannuation benefits in the form of a noncommutable income stream. For further details on the transition to retirement rules, see ¶16-155. This is no longer treated as a retirement income stream, so tax on earnings still applies in the superannuation fund. Termination of employment Termination of employment can constitute a condition of release, even though the employee has not reached preservation age. Benefits may be payable in the following circumstances: • termination of employment where the employer or an associate of the employer has contributed to the fund for members. In this instance: – preserved benefits are subject to the cashing restriction of meeting the SIS definition of retirement – restricted non-preserved benefits meet a cashing condition and can be withdrawn as a lump sum. • termination of employment where the member’s preserved benefits in the fund at the time are less than $200. What is the SIS definition of retirement? For SIS purposes, there are two definitions of retirement. They depend on the member’s age, as follows: • member of any age over preservation age — the member must have reached preservation age and an employment arrangement must have ceased (at any age), and the trustee must be satisfied that the member intends to never again become employed for 10 hours or more a week, and/or • member who is aged 60 or over — the member’s employment arrangement must have ceased on or after reaching age 60 regardless of the member’s intention to continue working. This means that from age 60 a member simply needs to leave a job to gain access to the accumulated superannuation benefits. The preservation age The preservation age for members born before 1 July 1960 is 55, but gradually increases so that for members born after 30 June 1964 it is 60 years of age. A table of preservation ages is provided at ¶4400.

Note Based on the birth dates, for anyone who has not yet reached preservation age, age 57 is the minimum age that will apply.

Special conditions of release In addition to the termination of employment situations discussed above, there are other conditions of

release where an employee can access benefits before reaching their preservation age, including: • permanent incapacity • permanent departure from Australia where an eligible temporary visa was held • severe financial hardship • compassionate grounds • terminal illness • temporary incapacity (limited release) • temporary early access (COVID-19) (limited release). These conditions are further discussed below. What is “permanent incapacity”? Since 1 July 2007, permanent incapacity is where the trustee is reasonably satisfied that the member is unlikely, because of the ill-health (whether mental or physical), to again engage in gainful employment for which the member is reasonably qualified by education, training or experience. This definition has removed the requirement that a member “cease to be gainfully employed”, which will potentially allow members who are not gainfully employed at the time that the illness occurs to receive a benefit under a permanent incapacity condition of release. What is permanent departure from Australia? Certain people who entered Australia on an eligible temporary resident visa and who permanently depart Australia will be able to receive payment of any superannuation they have accumulated. The measure only applies to individuals who hold, or have held, a temporary residence visa, not to all possible nonresidents. It does not apply to Australian citizens and permanent residents as these individuals always retain the option of returning and retiring in Australia. Access will be subject to withholding arrangements to return the tax concessions provided for the superannuation benefits. Normal lump sum tax rules do not apply. What is “financial hardship”? Whether a client can access their benefits on the grounds of financial hardship depends on their age: • under age 55 and 39 weeks — the client needs to have received, and still be receiving at the time of application to the trustee, Commonwealth income support payments for a continuous period of 26 weeks and the trustee must be satisfied that the person is unable to meet reasonable and immediate family living expenses. Under this rule, the maximum payment in a 12-month period is $10,000. • over preservation age and 39 weeks — the client needs to have been receiving Commonwealth income support payments for a cumulative period of 39 weeks after reaching the preservation age and must not be gainfully employed for more than 10 hours per week. In these circumstances, the client can withdraw up to their accrued benefit at the time of application. What are “compassionate benefits”? Compassionate benefits are those benefits that can be paid out by the fund due to the member satisfying compassionate grounds. The ATO is responsible for the administration of the early release. The range of grounds on which the ATO may release compassionate benefits has increased and includes: • paying for medical treatment or medical transport. For this to apply, the expenses must relate to lifethreatening illness or injury • paying for home or vehicle modifications or the purchase of disability aids due to severe disability

• paying expenses associated with palliative care • enabling the person to make a payment on a loan to prevent the foreclosure of a mortgage on the person’s principal residence or payment of council rates to avoid loss of the home • paying the expenses associated with the death, funeral or burial of a dependant.

Note The first three conditions relate to expenses that arise for the member or a dependant.

The amount that can be withdrawn from superannuation under these grounds is limited to the amount reasonably needed to cover the expenses. It is taxed as a normal lump sum so tax applies if under age 60. What is “terminal illness”? Terminal illness requires two medical practitioners (at least one must be a specialist in the relevant area) to certify that the person is likely to die within the next 24 months (prior to 1 July 2015 the period was 12 months). This releases the full account balance as a tax-free lump sum but it must be withdrawn and cannot remain in the superannuation fund. What is “temporary incapacity”? Temporary incapacity means ill-health (whether physical or mental) that caused the member to cease to be gainfully employed but does not constitute permanent incapacity. Benefits can only be released as a non-commutable income stream to replace salary for the period of incapacity. A discussion on some of the issues that superannuation trustees need to consider to understand preservation and access can be found in the practice guides on the APRA website. The relevant guide is Draft Prudential Practice Guide SPG 280 Payment Standards. Temporary early release (COVID-19) As a result of COVID-19, the government will allow temporary early access to superannuation for those financially impacted by COVID-19. The measures allow individuals to access up to $10,000 of their superannuation in 2019/20 (applications can be made between 20 April to 30 June 2020) and a further $10,000 in 2020/21 (applications can be made between 1 July to 31 December 2020). To apply for early release under the COVID-19 provisions, the individual must: • be unemployed, or • be eligible to receive a job seeker payment, youth allowance for jobseekers, parenting payment (which includes the single and partnered payments), special benefit or farm household allowance, or • on or after 1 January 2020 – be made redundant, or – their working hours were reduced by at least 20%, or – if the individual is a sole trader — the business was suspended or there was a reduction in turnover of at least 20%.

The application form can be accessed in one of two ways: • members can authenticate themselves through myGov and complete the application form in ATO Online, or • call the ATO to complete the application. The released amounts will not be subject to tax and will not affect any Centrelink or Veterans’ Affairs benefits. Australian citizens, permanent residents and New Zealand citizens with Australian held super are eligible to apply.

OTHER PLANNING ISSUES ¶15-510 Consolidation of superannuation benefits If a client has superannuation benefits across a number of different funds, it might be worthwhile consolidating the benefits into one superannuation fund. Reasons to consolidate superannuation funds include: • the potential for lower fees and charges • easier to keep track of benefits, and • simplified reporting with only one set of statements. People with multiple superannuation funds may lose track of the smaller accounts which will cause this money to be paid to the ATO as a lost account. If this occurs, less money is available to the client, although it can be recovered if the lost account is identified. By rolling all funds together, it gives the client greater visibility over all their money and reduces the time and effort to keep track of each account. This may also help to increase awareness and interest in their superannuation. Before making a recommendation to combine accounts, financial planners should ensure they have conducted a thorough switching analysis and advise clients on: • the potential loss of any benefits in the funds that are closed • the impact on overall fees • the implications for any insurance provided in the funds that are to be closed • the investment options and range.

Tip Before making a decision to consolidate funds it is also important to check the underlying tax components in each fund. If one fund is largely tax-free component it may be beneficial to leave it separated so that withdrawals remain largely tax-free. This may be important if this amount will be paid as a death benefit to a non-tax dependent or withdrawals are planned under age 60.

¶15-520 Financial and lifestyle issues Chapter 16 provides advisers with a discussion of the various options available in the marketplace to

create an income stream from their accumulated capital base in actual retirement. Although this chapter has focused on superannuation strategies, superannuation may not necessarily be your client’s main focus. When planning to retire, clients will be concerned with many other issues. These might include: • ensuring they will be able to maintain their lifestyle in retirement • uncertainty as to whether they will qualify for the Age Pension or any other benefits and how to maximise entitlements • business succession planning issues, especially the CGT exemption on the sale of small business proceeds invested in superannuation • re-evaluation of their living arrangements and the need to downsize their home or move into an assisted care environment or access home care in the future • estate planning, especially for clients with children from a previous marriage, former spouses or disabled children, and for those relying on social security benefits only available with couple assets test limits (¶19-265) • pre-retirement review of insurance needs to ensure retirement funding is preserved if redundancy, illness or accident prevents the client reaching normal retirement age. This is especially relevant for those in defined benefit schemes, or • proposed capital expenditures to upgrade cars, renovate homes and travel. Usually retirement means the end of formal employment or the selling of a business. For many clients it will mean the end of a regular income through salary or wages or business income. For this reason, retirement can be quite a traumatic event. Unexpected retirement through redundancy or ill-health might make retirement even more traumatic as the future suddenly becomes uncertain. The purpose of retirement planning is to ensure that clients will have a certain quality of life in their retirement. Each client will have somewhat different objectives but almost all clients will have limited resources. Often your clients will have a number of objectives and some of them might be conflicting. A financial planner’s role is to guide clients through identifying their needs and helping them to meet as many of their objectives as possible within the limits of their resources. Some of the typical objectives are: • to pay off their mortgage and take a holiday • to minimise the amount of tax that will be paid on retirement income • to minimise the amount of tax that has to be paid immediately • to maximise any entitlement to Centrelink benefits • to maximise retirement income and maintain purchasing power of the income • to preserve the capital • to provide some benefits to their children on their death.

¶15-530 Accepting the fact of retirement Some clients might have a difficult time accepting the fact of retirement. Clients who have been retrenched or are retiring because of ill-health might go through a particularly difficult adjustment phase. This will impact on the financial planning process in that clients might have difficulties in making decisions because of the uncertainty they face. A financial planner who recognises this will be appreciated by

clients. On the positive side, retirement can be an opportunity for clients to do the things that they might have postponed for many years.

¶15-540 Budgeting for retirement Budgeting before retirement means working out how to save an adequate amount of money to fund the desired lifestyle in retirement. As retirement approaches, however, it also means working out what assets clients wish to keep and whether there are assets which should be sold, upgraded or downsized. The objective might be to sell assets to generate a capital sum which may be invested in income-generating securities to increase retirement income. Clients might also be unsure as to how much income they will require in retirement. In that case they will need to prepare a budget. Most clients will have significant capital expenditure plans as retirement approaches and these expenses should also be considered in the budgeting process. They could be planning holidays, debt repayments, home improvements and gifts to children. It is a financial planner’s role to identify how these capital expenditure needs might be met, whether they are realistic or affordable and to what extent they might impact on clients’ retirement income goals.

¶15-560 How health issues affect retirement When planning a client’s retirement, it is important to recognise that some decisions depend on factors such as: • how long the client thinks they will live. The longevity of parents is a factor here as well as personal health and lifestyle choices. • the medical history of the client, so that some appreciation of the likelihood of various health problems can be gauged. • the potential need to access aged care services in the home or move to a residential aged care facility and the cost of these services. Health issues may impact a client’s ability to live independently and can also affect expenditure needs and patterns. Required expenditure could potentially increase if a client is experiencing frailty due to health matters, mental capacity or age. Clients need to have a plan well in advance of this decline, which includes: • appropriate housing option • how to access support services • the cost of accommodation or support services as well as other health care costs. It is also important that clients have put into place an Enduring Power of Attorney and Enduring Power of Guardianship (different names apply in different states/territories) to ensure someone else is able to act and make decisions if the client is no longer able to do so on their own (see also ¶19-455).

¶15-570 Where to live post-retirement Another issue that planners might need to address when planning a client’s retirement is the question of housing as well as access to care as they get older (or health declines). This includes the potential need for home care and/or residential aged care (refer to ¶17-000). If the client does not own their own home, living expenses are likely to be higher and generating income to cover rent or accommodation may need to be generated with minimal volatility and risk. To reduce ongoing income needs, clients who retire without owning a property may wish to consider

using some of their savings to purchase a property. This may be a traditional home (or apartment) or may be in a special accommodation such as a retirement village, over-50s park (land lease community) or granny flat arrangement with a family member. Refer to ¶12-000 for a discussion around the implications for purchasing a family home, including tax considerations. Owning a home may also help a client to be eligible for a higher level of social security income support as the home is an exempt asset (¶6-560). Other clients might feel that their existing property is no longer suitable due to the high maintenance costs. These clients may wish to consider options for downsizing or moving to a retirement village or over50s park (land lease community) to benefit from community living. These decisions need to consider all aspect of the financial arrangements including entry contributions, ongoing service fees, the expected sale proceeds (after applicable fees) upon departure and any social security implications (¶17-240). Legal advice should be sought to review contracts to understand the obligations, rights and future exit arrangements. Clients who sell a home may be able to contribute up to $300,000 of the sale proceeds into superannuation using the downsizer contribution rules (¶15-198). This can help to turn equity into taxeffective income if that equity is not needed to purchase the next home or accommodation arrangement. Where a client’s main asset is the family home and the client wishes to continue living there, if income sources are inadequate, they may consider the option of taking a reverse mortgage or other equity release option over the home to fund their retirement income needs or capital expenses (¶12-700).

¶15-580 Insurance needs after retirement When planning a client’s retirement, their insurance needs should be reviewed. On leaving a superannuation plan, cover which had been provided by that plan for death and disability will usually terminate. However, continuation options may be available (particularly from employer default funds) and should be assessed. In many cases these options provide a cost-effective way to ensure basic cover for life insurance and permanent disability, without the need for medical underwriting. However, for many clients, life insurance might not be required. Often, life insurance is reduced as liabilities reduce and assets increase. Similarly, once children are no longer dependent, one of the reasons for taking out the insurance may no longer be valid. Cost is another consideration. Insurance premiums may rise sharply with the insured’s age (unless a level premium was selected). As your client approaches retirement, the cost of insurance premiums might be prohibitive for the benefit received. Also, insurance cover might simply not be available beyond a certain age. It is important to note that some clients will have specific needs in relation to insurance planning. Often these needs arise because of estate planning considerations. For example, your client might have a need for life insurance to ensure that there are sufficient liquid assets in the estate in case of their premature death. It is also important to review “Nomination of Beneficiaries” forms and to ensure that life insurance policies are held in appropriate names. For further details on such planning issues, refer to ¶19-365. On the other hand, as your client ages, the need for medical and general insurance might be greater. Some clients might have had coverage through their employer and now need to consider the available options. As an adviser you should be able to guide them through these options.

¶15-590 Estate planning Although there is a need for estate planning throughout your client’s life, it often only becomes a focus at the retirement planning stage. At that time clients start to think about the issues in relation to the passing of their accumulated assets to the next generation. There are many issues which might come into play at this time. These might include any of the following: • Should a discretionary or testamentary trust be established? • Should binding nominations be established to direct superannuation death benefits to particular dependants?

• Are wills up to date? • Are insurance policies correctly structured? • What are the tax consequences of bequeathing certain assets? • Are there any taxation implications which might result in inequities among beneficiaries? • Have your client’s wishes been properly documented? • Are enduring powers of attorney and enduring powers of guardianship in place? • Are there any issues that require specific planning, such as bequests to charities? • Are there any “blended family” issues? See further Chapter 19.

RETIREMENT INCOME STREAMS The big picture

¶16-000

Income in retirement Key objective of retirement planning

¶16-100

Longevity risk and retirement income

¶16-110

How much income is needed?

¶16-115

Social security in retirement

¶16-120

Income stream categories

¶16-130

Retirement income covenant

¶16-135

Retirement income stream review

¶16-137

Considerations in selecting an income stream

¶16-145

Self-managed superannuation funds

¶16-148

Transfer balance cap and starting an income stream When can an income stream commence?

¶16-150

Assessment against the transfer balance cap

¶16-155

Transitional CGT relief

¶16-168

Exceeding the transfer balance cap

¶16-170

Capped defined benefit income streams

¶16-180

Income stream types Categorising income streams

¶16-190

Comparison of income streams

¶16-195

Fixed term income streams

¶16-200

Investment security of fixed term income streams

¶16-250

Advantages and disadvantages of fixed term income streams

¶16-260

Lifetime income streams

¶16-300

Reversionary nominations on lifetime income streams

¶16-330

Advantages and disadvantages of lifetime income streams

¶16-360

Term allocated pensions (TAPs)

¶16-400

TAP income payments

¶16-410

Advantages and disadvantages of term allocated pensions (TAPs) ¶16-440 Account-based pensions

¶16-500

Account-based pension income limits

¶16-510

Impact of commutations from an account-based pension

¶16-520

Advantages and disadvantages of account-based pensions

¶16-540

Longevity income streams and CIPRs

¶16-570

Retirement portfolio construction Making income stream payments

¶16-575

Retirement portfolio strategies

¶16-580

Transition to retirement rules

¶16-585

Generating income from other investment options

¶16-587

Income splitting

¶16-589

Social security and aged care assessment Social security and aged care assessment

¶16-590

Account-based pension assessment

¶16-591

Fixed term income stream assessment

¶16-592

Lifetime income stream assessment

¶16-593

Term allocated pension assessment

¶16-596

Social security deductible amount rules

¶16-598

Maximising retirement income — strategies Maximising income in fixed term and lifetime income streams

¶16-600

Transition to retirement and salary sacrifice strategy

¶16-610

Strategies to maximise social security with income streams

¶16-620

Strategies to minimise aged care fees

¶16-630

Changing income stream providers

¶16-640

Taxation of income streams Introduction to taxation of income streams

¶16-700

Tax on income streams (commenced from 1 July 2007)

¶16-710

Tax on income streams commenced before 1 July 2007

¶16-720

Tax collected under the PAYG system for taxation

¶16-730

The deductible amount and “relevant number” for taxation

¶16-740

Maximising the tax-free component

¶16-750

Commuting a pre-1 July 2007 income stream

¶16-760

Income stream tax offset

¶16-770

Taxation of commutations

¶16-780

Foreign superannuation income streams

¶16-800

Income streams from non-complying Australian funds

¶16-810

Complying income streams Criteria for complying income streams

¶16-830

Commuting complying income streams

¶16-840

Death benefit from income streams Payment of death benefits

¶16-900

Taxation of death benefit income stream

¶16-910

Commutation of death benefit income stream

¶16-920

Child account-based pensions

¶16-930

Transfer balance caps and death benefit income streams

¶16-940

¶16-000 Retirement income streams

The big picture Key objective of retirement planning: Income is the most important part of a financial plan at any stage of life. The financial plan must provide a regular, secure and growing income to allow clients to meet expenses. The level of income generated should grow over time to keep up with inflation. ¶16100 Longevity risk: The financial plan should also take into consideration the importance of longevity risk, that is, the chance that the client will outlive their savings, and include strategies for managing or minimising this risk. ¶16-110 Income stream categories: • Account-based income streams: offer greater flexibility and provide the potential for higher growth but with greater market risk. • Non-account based income streams: payable for either a fixed term or life. They provide fixed and guaranteed returns for the term of the income stream. ¶16-130 Transfer balance cap and starting an income stream • When can an income stream commence? As a general rule, to start a superannuation income stream the money must be unrestricted non-preserved, that is, fully accessible. Ordinary money income streams can be purchased at any time. ¶16-150 • Assessment against the transfer balance cap: from 1 July 2017 a transfer balance cap limit applies to limit the amount that can be rolled over from accumulation phase of superannuation into the tax-free retirement phase to pay an income stream ¶16-155 • Exceeding the balance transfer cap: if the transfer balance cap is exceeded the excess must be removed from the pension phase and a tax penalty may apply on the notional earnings ¶16-170 • Capped defined benefit income streams: defined benefit income streams are impacted by the transfer balance cap, but modified rules apply because it is usually not possible to commute part of the income stream to comply with the cap ¶16-180 Comparison of income streams: This handy table compares some of the features of the different types of income streams available. ¶16-195 Types of income streams: • Fixed term income streams — are payable for a set number of years and can be purchased with superannuation or ordinary money ¶16-200. Advantages and disadvantages of fixed term income streams are discussed at ¶16-260. • Lifetime income streams — pay a regular income to the client for their life, or if purchased with ordinary money, for the life of the last surviving joint owner ¶16-300. Advantages and disadvantages of lifetime income streams are discussed at ¶16-360. • Account-based (allocated) pensions — offer the greatest flexibility for clients but also the highest investment and longevity risks ¶16-500. Advantages and disadvantages of account-based

pensions are discussed at ¶16-540 • Deferred income and CIPRs — a new emerging category to manage longevity risk more effectively with opportunities for improved investment returns and access to capital and supported by changes to social security rules ¶16-570 Retirement portfolio construction • Making income payments ¶16-575 • Retirement portfolio strategies ¶16-580 • Transition to retirement income stream ¶16-585 • Generating income from other sources ¶16-587 • Income splitting ¶16-589 Social security and aged care assessment: • Account-based pensions ¶16-591 • Fixed term income streams ¶16-592 • Lifetime income streams ¶16-593 • Term allocated pensions ¶16-596 • Deductible amount rules ¶16-598 Strategies to maximise retirement income: • Fixed term and lifetime income streams ¶16-600 • Transition to retirement strategy ¶16-610 • Strategies to maximise social security benefits with income streams ¶16-620 • Strategies to minimise aged care fees ¶16-630 • Changing income stream providers ¶16-640 Taxation of income streams: Superannuation income streams are tax-effective vehicles for generating an income stream. The tax benefits depend on the client’s age at the time that a payment is received and calculation of exempt current pension income ¶16-700 Death benefit payments from income streams: • Payment of death benefits ¶16-900 • Taxation of death benefit income stream ¶16-910 • Commutation of death benefit income stream ¶16-920 • Transfer balance caps and death benefit income streams ¶16-940

INCOME IN RETIREMENT

¶16-100 Key objective of retirement planning Income is the most important part of a financial plan at any stage of life. During the accumulation phase, income needs are met by salary or wages. Once retirement is reached, the pay packet ceases and income must be generated from resources built up by the client, with a safety net provided by the government through the Age Pension. Therefore, retirement requires careful preparation and financial planning. The financial plan must provide a regular, secure and growing income to allow clients to meet expenses. The level of income generated should grow over time to keep up with inflation. The financial plan should also take into consideration the importance of longevity risk, that is, the chance that the client will outlive their savings, and include strategies for managing or minimising this risk. The portfolio construction strategy implemented for a retirement income plan is important to consider when providing advice on income streams to clients (¶16-580). Significant changes were made to the taxation rules and strategy implications for superannuation income streams from 1 July 2017. In particular, the amount that can be used to commence superannuation income streams is limited to the transfer balance cap (¶16-155). The general rate remains at $1.6m for 2020/21 as it has not indexed since introduction on 1 July 2017. Income needs Income may be considered in two components: • basic necessary income to meet all daily expenses (eg food, utilities, clothes, health care etc) • discretionary income to cover other irregular expenses (eg holidays, entertainment, etc). Clients need a greater level of security and certainty to meet their daily income needs through regular (and possibly stable) income. Discretionary income enables the client to maintain their desired lifestyle and meet unexpected expenses. This income can be provided either from a regular income source or through withdrawals of capital. Once income needs are met and a cash reserve has been put in place, any money that is left over may be invested in growth assets to build capital for future needs or to help provide a growing income stream to increase the lifestyle component. Clients in retirement may become more risk-averse compared to before retirement as they may lack the time or opportunity to replace any losses. However, they should also be aware that they are typically planning for a 20-year-plus timeframe and should aim to achieve some growth on their investments to cope with inflation. It is also important to consider that total income needs may not decrease as a person gets older and could even increase in later stages when frailty needs emerge (the frailty risk). Comparisons of income needs in the Association of Superannuation Funds of Australia (ASFA) Retirement Standards show only a $1,500 a year reduction in income for an 85-year-old compared to a 65-year-old (modest retirement) but this assumes no health issues or care needs. What is evident is that expenditure patterns adjust throughout retirement. For example, expenses for items such as travel and personal expenditure may reduce as a person ages while medical expenses and costs for aged care or home assistance may increase. The cost and need for care in the future is likely to increase from current levels. Therefore, the impact on lifestyle quality can be significant if growth is not achieved.

¶16-110 Longevity risk and retirement income Life expectancies are increasing and Australia has one of the highest life expectancies in the world. It is not unreasonable for clients to expect to live beyond age 85 and into their 90s. This longevity risk, along with frailty risk, needs to be taken into consideration when planning for the duration of a retirement. The statistical life expectancies are derived from historical data and may not adequately reflect the actual life expectancy of a living person. The stated life expectancies are averages. This means that a person has a 50% chance of living beyond the stated age. For example, a 65-year-old male currently has a statistical life expectancy of 19.90 years to just under age 85 while a 65-year-old female has a statistical

life expectancy of 22.60 years (based on 2016/18 Life Tables issued by the Australian Bureau of Statistics). This means these people have a 50% chance of living beyond age 85 and 87 respectively. According to the Australian Bureau of Statistics, the proportion of the population aged 65 and over is expected to grow from 14% in 2011 to almost 25% by 2051. The proportion aged 85 and over is also expected to significantly increase from 1.8% in 2011 to around 5% by 2050.

Source: ABS cat. no. 3105.0.65.001 (2008) and Treasury projections as reported in Australia to 2050: future challenges, released by The Treasurer Wayne Swan in January 2010. With the Age Pension paid at a level that approximates the poverty line and generally below what most retirees need to live on in retirement (according to the ASFA Retirement Standard survey for even a modest income), many retirees cannot afford to run out of private income sources in their older years. The age at which the Age Pension can be accessed is increasing, so clients may need to be more selfsufficient, particularly in the earlier years of their retirement. From 1 July 2019, the pension age increased to 66 (for anyone born on or after 1 July 1954) and is gradually increasing up to age 67 by 1 July 2023. Service pension age for veterans is remaining at age 60. The increasing period in retirement requires careful management of the client’s finances to generate enough growth to make their money last the distance, but also needs to balance expenditure with affordability.

¶16-115 How much income is needed? Income needs for each retiree will vary based on their lifestyle expectations, expenses, where they live, family situation, life expectancy and health. Many studies and publications have focused on the question of how much is needed for retirees to live on. In December 2002, the Senate Select Committee on Superannuation’s Inquiry into Superannuation and Standards of Living in Retirement expressed the view that Australians should generate a retirement income of approximately 65% of gross pre-retirement income at age 65.

The question of “adequacy” was considered in the “Australia’s Future Tax System Review” report (the Henry Review). The Henry Review recommended a range of tax changes to superannuation aimed at addressing the issue of adequacy with what the review panel believed was a more equitable distribution of concessions, however, most recommendations were not accepted by the government. One measure that has been introduced is a gradual increase in superannuation guarantee (SG) up to 12% per annum by 1 July 2025. The ASFA Retirement Living Standards look at what incomes people need in retirement. The March 2020 quarter update (for a 65-year-old) shows that: • a “comfortable” lifestyle needs $62,435 pa for a couple or $44,183 pa for a single person • a “modest” lifestyle needs $40,719 pa for a couple and $28,220 pa for a single person. ASFA also produces figures for a person aged around 85 and the difference is only around $1,500 less for a modest retirement and about $2,000 less per person for a comfortable retirement. The ASFA study income levels (particularly for a comfortable retirement) are significantly higher than the income provided by the Age Pension ($24,552 pa for a single person and $37,014 pa for a couple combined — rates current to 19 September 2020). It should also be noted that the income levels are only a guide and assume that the person owns their own home, no major unexpected expenses occur and no major health or care needs are evident.

¶16-120 Social security in retirement Social security benefits are available to top up private income for clients who satisfy the eligibility criteria (¶6-100). This system aims to ensure that everyone is able to at least purchase the basic necessities of life. Veterans receive payments through the Department of Veterans’ Affairs (DVA). The type of payment and the amount payable is based on eligibility criteria such as age, marital status, and assets and income levels (¶6-520, ¶6-540). The maximum Age Pension is indexed each six months (March and September). This indexation has been linked to the greater of the movement in the Consumer Price Index (CPI) and the Pensioner and Beneficiary Living Cost Index (PBLCI), with the single Age Pension also guaranteed to remain at least equal to 27.7% of the Male Total Average Weekly Earnings (MTAWE) and equal to 67% of the combined couple rate of pension. Significant reductions in the asset test cut-off thresholds applied from 1 January 2017 due to a change in the taper rate for reducing the amount payable. This reduced the number of people who qualified for part age pensions and the amount of pension payable to many retirees. The impact is an even greater need for clients to be self-reliant. Social security implications can be a major influence on financial decisions and should be considered when preparing a financial plan. In some cases, total income may be increased and the client’s overall financial situation improved by implementing strategies to maximise social security or DVA entitlements. However, financial planners should ensure maximisation of the client’s total wealth, not just their social security/DVA benefits. Social security rules are discussed in detail in ¶6-000 and income stream rules are discussed at ¶16-591– ¶16-596. The means testing rules for means tested Veterans’ Affairs payments are essentially the same as social security rules.

¶16-130 Income stream categories Major changes were made to the SIS definitions and taxation rules for income streams from 1 July 2007. From this date, income streams fall into the following two categories: • non-account based income streams

• account-based income streams. Non-account based income streams are payable for either a fixed term (¶16-200) or life (¶16-300). They may be known as immediate annuities, fixed term income streams, life expectancy income streams or lifetime income streams. They provide fixed, guaranteed returns and for some clients may satisfy the “comfort factor” for essential income needs. Account-based pensions (¶16-500) provide the potential for better growth and investment performance and offer the greatest flexibility, but this comes with higher market risk. They were previously known as allocated pensions. Term allocated pensions (TAP) (¶16-400) are a form of account-based pension but have special rules. TAPs have generally not been offered since 20 September 2007, except where rolling over an existing complying pension to a new pension which is offered by some providers. A matrix comparing features in each category can be found at ¶16-195. Non-account based annuities (both lifetime and fixed term) are the only income streams that can be purchased with ordinary money. With forward planning, it may be possible for a client to use ordinary money to make a contribution to superannuation and then purchase an income stream. Eligibility to contribute to superannuation is discussed at ¶4-205. Non-commutable income streams commenced before 19 September 2007 may have been classified as complying income streams (¶16-830) with additional tax and social security advantages. Care needs to be taken if clients wish to commute these income streams (¶16-840). Difference between pensions and annuities Income streams may be in the form of an annuity or a pension, but there is very little practical difference. The income payments from a pension are paid by a superannuation fund. The basis for payment is defined by the terms of the trust deed and the member’s eligibility. Annuity payments are paid by a life insurance company or registered organisation to the policy owner (investor). The payments arise from the terms of the contract between the life company and the policy owner. Annuities may be purchased with superannuation or ordinary money. Product developments A number of innovations have been experienced in the income stream market in recent years, particularly with the proposed introduction of the retirement income covenant (¶16-135) which is aimed at removing longevity risk from retirement plans and opening up innovation in retirement income products. Changes to legislation and regulations to introduce deferred income streams (¶16-570) will lead to the development of lifetime superannuation income streams that manage longevity risk for clients. This may include products such as deferred income streams, investment-linked pensions and pooled lifetime income streams. These products may include either a guaranteed lifetime payment by the provider or payments determined by either the returns on a collective pool of assets or mortality experience of members of the fund. In addition, work over a number of years has focused on the pending introduction and development CIPRs (¶16-570). Changes to the social security rules for assessing certain lifetime income streams which became effective from 1 July 2019 may pave the way for the development of CIPRs and deferred income streams.

¶16-135 Retirement income covenant In recent years, the government has been working on the development of a retirement income framework with plans to introduce a retirement income covenant into the Superannuation Industry (Supervision) Act 1993 (SISA). Included in the 2018 Federal Budget was a commitment to introduce a retirement income covenant as the first stage of this framework. The aim is to codify the requirements and obligations for superannuation fund trustees in relation to better meeting retirement needs of members. This will add to the existing covenants in SISA that cover the obligations for investment, risk management and insurance strategies.

All superannuation fund trustees (including trustees of self-managed superannuation funds) would be required to develop a retirement income strategy for members and provide the parameters of what needs to be included. It will not apply to defined benefit schemes that offer a lifetime pension. With the introduction of the retirement income covenant, trustees will be required to consider the retirement income needs and preferences of members and ensure retirees have greater choice in how they take superannuation benefits in retirement. This strategy will also see trustees required to offer a flagship Comprehensive Income Products for Retirement (CIPRs) (¶16-570) with advice support to members. Legislation was proposed to be introduced by 1 July 2019 with commencement from 1 July 2020. At the time of writing, no legislation has been introduced but an announcement has been made to defer commencement until 1 July 2022.

¶16-137 Retirement income stream review Following a review by the Productivity Commission in its report Superannuation Assessing Efficiency and Competitiveness, the government announced a review into the retirement income system on 27 September 2019. The review will cover the current state of the system and how it will perform in the future as Australians live longer and the population ages. Included in the terms of reference are consideration of the incentives for people to self-fund their retirement, the fiscal sustainability of the system, the role of the three pillars of the retirement income system and the level of support provided to different cohorts across time. The final report was due to be provided to government by June 2020.

¶16-145 Considerations in selecting an income stream Income streams are an efficient option for creating regular income to meet living expenses. In particular, strategies for superannuation income streams are popular due to the taxation advantages from the tax-free earnings. Lifetime and term certain annuities purchased with ordinary money can help with risk management strategies. Choosing the right income stream for a client can be difficult and complex. Advisers need to be familiar with the jargon and terminology. Fund managers and income stream providers call their products by a variety of marketing names. In some portfolio strategies (¶16-580) non-account based income streams may be used to provide a client’s basic income needs (to reduce uncertainty) with an account-based pension used to provide the discretionary income needs or to produce higher potential returns to help manage inflationary risk. However, in many strategies, account-based pensions are used to fund all or most of the client’s income needs. A new breed of account-based pensions has emerged over the past decade with guarantees to pay a certain amount of income for life, even after the account balance reduces to nil. These were often generically referred to as longevity income streams (¶16-570) or deferred income streams, but operated under various marketing names. These products have not been popular to date, but are expected to become more popular with changes in government policy and legislation. Superannuation fund trustees will be required to offer CIPRs as their flagship retirement income stream product (¶16-570). Members will continue to have choice to invest in a CIPR or other retirement income stream product. The first step in selecting an income stream is to decide if the client needs a fixed or variable income stream and determine their appetite to take on longevity risk. It can then be determined which is the most suitable income stream to meet these needs. This may require a combination of income streams or other income sources. Issues such as cost and flexibility as well as health and life expectation will need to be taken into consideration. Trade-offs

A financial planner will often encounter clients whose resources do not allow them to fund their desired lifestyle. In such cases, it will be necessary to choose the most cost-efficient income stream and perhaps trade-off optional features if the costs use up too much of the client’s available assets. Alternatively, the client may need to trade-off lifestyle. Checklist of considerations Issues that should be considered when making a recommendation for an appropriate income stream include: • type of income stream — fixed term pension or annuity (¶16-200), lifetime pension or annuity (¶16300), account-based pension (¶16-500) or longevity income stream (¶16-570) • access to capital — either as a residual capital value (RCV) (¶16-200), lump sum withdrawals or income payments • the transfer balance cap available — from 1 July 2017 the amount that can be used to start a retirement phase income stream using superannuation money is limited to the available cap amount. This includes the 30 June 2017 value of any income streams commenced before that date (¶16-155). • client’s objectives for capital such as: – to create an inheritance for dependants – to cover future capital needs (including costs of aged care or accommodation changes) – to provide tax-effective income – to minimise longevity risk • inflation protection — indexation of income to preserve purchasing power • social security implications (¶16-590 to ¶16-598) or impact on aged care costs • the options for transfer of ownership on death (¶19-610 and ¶19-665) including: – automatic reversionary or binding death nomination – differences between pensions and annuities – taxation of death benefit payments. Benefits of deferred income stream products and CIPRs These products may provide the benefit of purchasing a flexible account-based pension with a portion of the client’s savings but eliminate some longevity risk with a deferred lifetime income stream option purchased with the rest of savings. Further product developments may arise. To assess the value of these options, consideration should be given to: • the health and life expectancy of the client • the cost of any guarantees (specific fees charged) that might be provided (CIPRs do not have to offer guarantees) • details of what is guaranteed • levels of indexation on guaranteed income • the potential to be locked into a provider and the strength of any guarantees • the investment management and performance of the provider.

The longevity investment may provide good value for clients expected to live to an older age but depending on the product structure, the cost of the guarantee may provide no value if the client dies before any deferred guaranteed income commences.

¶16-148 Self-managed superannuation funds Self-managed superannuation funds (SMSFs) can pay income streams, subject to any restrictions in the trust deed. Trustees need to comply with the normal taxation and SIS requirements. SMSFs are discussed in ¶5-000 and following. However, an SMSF is limited to starting only new account-based pensions. Non-account based income streams can only be commenced by an SMSF if purchased from an external life company. Therefore, an SMSF is able to commence: • an account-based pension (including under the transition to retirement rules) • a term allocated pension • a fixed term or lifetime pension that is purchased from a life company. If an SMSF is used to accumulate superannuation benefits but the client no longer wishes to accept the trustee responsibilities, capital gains tax (CGT) implications should be considered before the fund is closed. Any funds remaining in the accumulation phase when closed will be subject to tax on the taxable portion of any realised capital gains. If a retirement phase pension commences before the fund is closed, tax is not payable on any capital gains realised in the pension phase. It should be noted that for taxation purposes, pensions commenced under the transition to retirement rules are not considered as retirement phase pensions and as such, remain subject to taxation (¶16-585) under the same rules that apply in the accumulation phase. Example An SMSF has a balance of $470,000, including unrealised capital gains of $90,000. All assets have been held longer than 12 months. If the fund is closed while in the accumulation phase, CGT of ($90,000 × ⅔) × 15% = $9,000 is payable by the fund. This leaves only $461,000 to be paid as a lump sum benefit or to be rolled over to an income stream with another fund. If an account-based pension is commenced in the SMSF before selling the assets (under a full condition of release so that assets backing the pension are in the retirement pension phase), no tax is payable on the realised capital gains. This allows the full $470,000 to be paid out or rolled over to start the income stream in a new fund.

TRANSFER BALANCE CAP AND STARTING AN INCOME STREAM ¶16-150 When can an income stream commence? As a general rule, to start a superannuation income stream the money must be unrestricted nonpreserved, ie fully accessible (¶15-400). An exception applies for an income stream that is purchased under the transition to retirement rules (¶16-585) as it can be purchased with preserved money but limitations apply on amounts that can be withdrawn each year and the tax concessions available to retirement phase income streams do not apply. Ordinary money income streams can be purchased at any time. When planning how to generate a client’s income, it is important to remember that the commencement of an income stream may lock the client into the arrangement to some degree. What happens if the client’s circumstances change? This could generate income that is surplus to the client’s needs and may impact taxation and/or social security. In some cases, the income stream can be commuted and rolled back to the accumulation phase of superannuation or to another income stream option but this may incur costs and may lose concessions. If the client commenced a complying income stream (ie non-commutable lifetime, fixed term or term

allocated pension purchased before 20 September 2007 and meets certain requirements) it can only be commuted in limited special circumstances, including to be rolled to another complying non-commutable income stream (¶16-830). Lifetime income streams may not be commutable once commenced. Details need to be checked in the particular contract offered by the provider. Example John was made redundant at age 58. At the time he thought he would not work again so he declared permanent retirement as a condition of release and started an account-based pension to meet his regular living expenses. However, a year later he feels more positive about his future. John finds new employment and no longer needs the income from his pension. John could decide to commute the pension and roll the money back into superannuation. This would reduce the amount that has been calculated against his transfer balance cap (through a debit to his transfer balance account). Alternatively, he could continue the income stream and contribute the excess salary into superannuation (subject to the concessional contribution cap) using salary sacrifice or by making personal deductible contributions. If John was uncertain about his future, instead of commencing an income stream immediately, he could have retained his superannuation benefits in the accumulation phase and drawn lump sums from the fund as needed to cover his living expenses. However, this uncertainty around future work intentions may have precluded him from accessing his money as either an income stream or a lump sum. To access his super, he needed to meet the retirement condition of release which means he must not have intended (at that point in time) to ever return to work for more than 10 hours per week. If this intention did not apply his money remains preserved. The taxation and social security implications as well as fees at both the fund level and on his personal income should be considered when making these decisions.

Start an income stream or remain in accumulation? A client can choose to remain in the accumulation phase indefinitely. Once they reach age 60, amounts that are able to be withdrawn as lump sums or as income (from a taxed fund) can be received tax-free and are not counted as taxable income. However, while the client remains in the accumulation phase, the fund will pay tax on earnings (including the assessable portion of realised capital gains) at the rate of 15%. If an income stream is started, the fund will no longer pay tax on current segregated assets used to support the pension provided it has been commenced due to a full condition of release (ie the tax-free status does not apply to income streams paid under transition to retirement rules (¶16-585)). This increases the effective earning rate and can help the client’s money last longer. The amount that can be used to start a superannuation income stream is limited by the transfer balance cap rules (¶16-155). If this limit is exceeded, the balance can be retained in the accumulation phase or be withdrawn from superannuation.

¶16-155 Assessment against the transfer balance cap From 1 July 2017 the transfer balance cap rules limit how much can be rolled over from accumulation phase of superannuation into the tax-free retirement phase to pay an income stream. The general transfer balance cap started at $1.6m and remains at this level in 2020/21. The cap is indexed on 1 July in line with the consumer price index (CPI) but is rounded down to the nearest $100,000. What counts against the cap? The values of affected superannuation income streams are credited to a person’s transfer balance account. The balance of this account is then measured against the person’s personal transfer balance cap to determine if an excess is created. The following income streams will create a credit to the transfer balance account: • income streams commenced before 1 July 2017 were credited at the 30 June 2017 closing balance • the purchase price of account-based income streams commenced from 1 July 2017 is credited at commencement

• defined benefit income streams are assessed but special rules apply to calculate the value and determine whether an excess applies — refer to ¶16-180. This includes pension income received from a former spouse’s super pension as part of a family court settlement. • death benefit pensions are credited to the beneficiary’s transfer balance account (¶16-940) with special rules for child account-based pensions (¶16-930). Amounts that do not create a credit in the transfer balance account include: • the growth in an income stream after commencement (unless captured in the 30 June 2017 balance for a pension commenced before 1 July 2017) • pensions payable under transition to retirement rules (¶16-585) • personal injury structured settlement contributions that have been transferred into the pension phase (these amounts are originally credited but a debit then applies to remove the value from the transfer balance account). The personal transfer balance cap and indexation A person’s personal transfer balance cap is set at an amount equal to the general transfer balance cap that applies in the financial year they first commence an affected income stream. If the personal transfer cap is fully used in that year, the person will not benefit from any future indexation of the general transfer balance cap. Example Cliff started an account-based pension on 1 August 2020 for $1.6m and leaves the balance of his superannuation savings in the accumulation phase. His personal transfer balance cap is set at $1.6m and is used up in full. If the general transfer balance cap indexes on 1 July 2021 he is not able to use this indexation to start a further income stream.

If the personal transfer balance cap is only partially used, the person will only receive part of the indexation in subsequent years, based on a proportion of the available cap remaining, that is, only the unused cap portion is indexed. Example Clarissa started an account-based pension on 1 August 2020 for $800,000. Her personal transfer balance cap is set at $1.6m. Half (50%) of this cap remains unused. Assume the general transfer balance cap indexes by $100,000 on 1 July 2021 to $1.7m. Her personal transfer balance cap will increase to $1,650,000 (ie increases by 50% of $100,000 increase).

Debits to pension transfer balance cap If lump sum withdrawals are made from an affected income stream, this will create a debit in the person’s transfer balance account to reduce the amount assessed. Debits do not apply for pension payments made. A debit will also apply to adjustments to meet family law settlements.

¶16-168 Transitional CGT relief People who were likely to exceed the cap on 1 July 2017 may have needed to commute all or some of income streams back into accumulation phase to ensure the cap was not exceeded. To avoid creating a CGT liability on growth accumulated to that date, transitional CGT relief was made available. If a person transferred assets from the pension phase back into accumulation phase before 1 July 2017 to ensure their balance remained under the cap, the CGT relief could be claimed to reset the cost base of those assets to the market value at that time. By claiming this relief, capital gains tax would only apply to the growth from the date of transfer back into accumulation phase.

This relief was also applied to transition to retirement income streams that continued beyond 1 July 2017 as the supporting assets are deemed to have been moved back into accumulation phase at that point. This relief only applied to assets that were held by the superannuation fund before 9 November 2016 (when announcements were made).

¶16-170 Exceeding the transfer balance cap A person who has accumulated superannuation savings greater than the transfer balance cap should not transfer more than the cap amount (or available personal cap amount) into the pension phase to start an income stream. Example Bert has superannuation savings of $1.8m when he retires at age 66 in October 2020. Bert rolls $1.6m into an account-based pension. His personal transfer balance cap is set at $1.6m and his transfer balance account is credited with $1.6m. The remaining $200,000 can remain in accumulation phase or be withdrawn as a lump sum. Bert has not created an excess transfer balance. He has fully used his personal transfer balance cap and will not benefit from any future indexation of the general transfer balance cap. As such, he is not able to commence a pension with any further superannuation savings.

If the value of a person’s transfer balance account exceeds their personal transfer balance cap, they will create an excess transfer balance. The excess transfer balance is the sum of: • the amount exceeding their personal transfer balance cap, and • the notional earnings on the excess amount. The excess amount needs to be withdrawn from the pension phase. It can be rolled back into accumulation phase or be withdrawn as a cash lump sum. Excess transfer balance tax is payable on the notional earnings. Notional earnings If the transfer balance cap is exceeded at the end of a particular day, a notional earnings amount is calculated on this excess amount. The earnings are compounded daily until the excess is removed from the income phase or an excess transfer balance determination is issued by the ATO (whichever is earlier). The daily rate for earnings is calculated as: 90-day bank accepted bill yield + 7 percentage points Number of days in the calendar year The 90-day bank accepted bill yield is a benchmark indicator published by the Reserve Bank of Australia (RBA). Excess determination The ATO may issue an excess transfer balance determination to crystallise the amount that needs to be withdrawn from the income phase. This stops the accumulation of the notional earnings. The excess amount and notional earnings advised in the determination must be withdrawn from the income phase. This amount can be rolled back into accumulation phase or be withdrawn as a cash lump sum. If the withdrawal has not been made within 60 days of the determination being issued, the ATO will issue an automatic withdrawal notice to the superannuation fund. Tax on excess amount Excess transfer balance tax is payable on the notional earnings. The tax rate is:

• 15% for first time that an excess transfer balance is created, and • 30% for any subsequent excesses. If a person is liable for this tax, the ATO will issue an excess transfer balance tax assessment. The tax is due and payable 21 days after the assessment is issued. The general interest charge will apply to any late payments. The tax cannot be paid by the superannuation fund. It must be paid personally by the member.

Note A transitional measure allowed a person with existing income streams who exceeded the $1.6m cap on 1 July 2017, but by less than $100,000, to withdraw the excess before 31 December 2017 without creating a liability to pay excess transfer balance tax.

¶16-180 Capped defined benefit income streams Defined benefit pensions are impacted by the transfer balance cap, but modified rules apply because it is usually not possible to commute part of the income stream to comply with the cap. The modified rules apply to certain lifetime pensions started at any time as well as certain lifetime annuities and life expectancy or market-linked pensions and annuities that commenced before 1 July 2017. Clients should check with their superannuation fund to determine if the pension/annuity is a capped defined benefit income stream. Special value A “special value” needs to be calculated for a capped defined benefit income stream. This is the value that counts towards the transfer balance cap. The special value is calculated using the following steps: 1. Calculate the annual entitlement — annualise the first payment received from the income stream after the income stream commences (or after 1 July 2017 if the income stream commenced before that date) 2. Multiply the annual entitlement by the required factor. If it is a lifetime income stream, the factor is 16. If it is a non-commutable life expectancy or market-linked income stream, the factor is the number of years remaining (rounded up to nearest whole number). Only holding capped defined benefit income streams If the only income streams a person holds are capped defined benefit income streams the transfer balance cap cannot be exceeded, regardless of the special value calculation. This means an excess cannot be created and no commutation is required. However, if the annual benefit exceeds the defined benefit income cap (set at $100,000 from 1 July 2017 to 30 June 2021) the excess income may need to be included in the person’s assessable income and the tax offset will not apply. This income will be subject to personal taxation at the applicable marginal tax rate. Example Delores retires and starts to receive a defined benefit lifetime pension on 1 August 2020 with monthly income payments. Her first income payment of $8,726 will be received on 1 September. This is annualised to $104,712. The special value is $104,712 x 16 = $1,675,392. Delores’ pension has exceeded the transfer balance cap but as she does not have any other income streams she does not have an excess transfer balance.

The annual payment exceeds the defined benefit income cap so she may need to include part of the income as assessable income and this portion will not receive the pension tax offset.

Holding both capped defined benefit and account-based income streams If a person holds both capped defined benefit income streams and account-based income streams, the total included in the transfer balance account is assessed against: • the transfer balance cap, and • the capped defined benefit balance. If the balance of the transfer balance account exceeds both thresholds, the smaller of the two excess amounts is the excess transfer balance. By default, this cannot be more than the balance of the accountbased income stream. The excess transfer balance amount needs to be withdrawn from the account-based income stream as a cash lump sum withdrawal or as a rollover back to the accumulation phase. Excess transfer balance tax will be payable on the notional earnings. Example Bob receives a non-commutable defined benefit income stream with a special value of $1,675,392 starting in 2020/21. He also starts an account-based pension with $300,000 in the same year. He has exceeded the transfer balance cap by $375,392 but has exceeded the capped defined benefit balance by only $300,000. Therefore, he has an excess transfer balance of $300,000 (the lesser of the two). Bob will need to commute the account-based pension and may be subject to excess transfer balance tax on the notional earnings. Bob still exceeds the transfer balance cap but as this is only due to the defined benefit income stream, he does not need to commute any part of that income stream. If the annual income exceeds the defined benefit income cap, he may need to include part of that income as assessable income and eligibility for the offset is affected.

INCOME STREAM TYPES ¶16-190 Categorising income streams The abolition in 2007 of both Reasonable Benefit Limits (RBLs) and Centrelink/Veterans’ Affairs asset test exemptions was accompanied by a change to the definition of an income stream in SIS regulations. This changed the types and features of income streams offered from 20 September 2007. In particular, “complying” income streams which previously met the rules for an asset test exemption and access to the pension RBL were no longer required. Clients may still be invested in complying income streams which were purchased before that date and remain subject to the previous limitations (¶16-830). Under the SIS regulations income streams are divided into account-based and non-account based income streams. Superannuation savings can be used to purchase income streams in both categories but ordinary money can only be used to purchase non-account based income streams. Superannuation income streams cannot be used as security for any loans and can only be transferred to a death benefits dependant (as defined under tax law, see ¶19-610) upon the death of the client. Account-based income streams An account-based income stream has an account balance attributable to the client. These income streams must pay a minimum income each year equal to a set percentage of the account balance. The percentage is based on the client’s age at commencement and reviewed each 1 July. In this way the minimum income can fluctuate each year in line with changes in account balance. Regulations have been amended to apply a 50% reduction to the standard minimum pension factors for an account-based pension in 2019/20 and 2020/21 to assist people through the COVID-19 crisis.

Account-based income streams include: • account-based pensions (previously known as allocated pensions) (¶16-500) • term allocated pensions (also known as market linked income streams) (¶16-400) • some deferred income streams (¶16-570). Account-based income streams can only be purchased with superannuation savings. Non-account based income streams A non-account based income stream does not have an account balance attributable to the client. Instead the client purchases a guaranteed, regular income stream for a fixed term or life. The terms and conditions can vary between providers. Non-account based income streams include: • fixed term income streams (¶16-200), which pay income for a fixed number of years • lifetime income streams (¶16-300), which pay income for life. The first year income is agreed at the time of purchase and can remain fixed or be indexed in line with CPI, AWOTE or a fixed rate. Any residual capital value, commutation value or withdrawal benefit cannot exceed 100% of the purchase price. The commutation value of a superannuation income stream cannot exceed the amount of the benefit that was immediately payable before the commutation. Non-account based income streams may be offered as superannuation or ordinary money income streams.

¶16-195 Comparison of income streams The following table provides a brief comparison of features generally offered by the different income stream types. Conditions should be checked for a particular income stream as variations may occur between providers. This table can be used to help prioritise trade-offs for a client and select the appropriate mix of income streams. Account-based pension

Term allocated pension

Fixed term income Lifetime income stream stream

Term

Until account balance runs out (unless the product offers a longevity guarantee option)

Selected term between life expectancy and age 100

Selected term (up to Guaranteed for life number of years until client reaches age 100)

Access to capital

Yes (unless paid under transition to retirement rules)

No

Depends on product Generally no

Investment risk

Client carries market risk (there may be some protection in longevity income stream products)

Client carries market risk

Payments guaranteed by provider

Payments guaranteed by provider

Longevity risk Client carries The longer the term, The longer the term, The client minimises longevity risk as the lower the the lower the longevity risk due to money may run out. longevity risk longevity risk the lifetime

The longevity income streams may help to reduce this risk

guarantee

Income payments

Must receive at least the minimum which is a percentage of account balance (based on client’s age)

Based on remaining No flexibility — term each 1 July payments are fixed with only a small but can be indexed range of flexibility (+/− 10%)

Social security (asset test)

Account balance is fully assessable (even if noncommutable)

Account balance is assessable. A 50% exemption applies if purchased before 20 September 2007 or if purchased with the full rollover of another exempt TAP (rules apply)

Social security (income test)

Income received Income received less allowable less allowable deductible amount if deductible amount. client meets grandfathering rules. If grandfathering rules are not met or income stream is commenced after 31 December 2014, deeming rules will apply

Income received less allowable deductible amount. If term is less than five years, deeming applies unless that term is longer than statistical life expectancy at commencement

If purchased from 1 July 2019, 60% of income payment is assessable.

Assessed against cap (unless paid under the transition

Assessed against cap if using superannuation

Assessed against cap if using superannuation

Transfer balance cap

Assessed against cap

No flexibility — payments are fixed but can be indexed

Asset value reduces by return of capital in each income payment.

If purchased from 1 July 2019 and meets Capital Access Schedule (CAS) rules, 60% of If complying and purchase price is purchased before assessable until age 20 September 2007, 84 (or at least first 50% of asset value five years), then is exempt (or 100% reduces to 30%. exempt if purchased before 20 If CAS rules are not September 2004). If met, the assessable purchased with full value is the highest rollover of another of the future death/ exempt income surrender value or stream, the the value under the exemption is 60%/30% rule. retained provided all requirements are met If purchased before 1 July 2019 assessed under same rules as fixed term income streams.

If purchased before 1 July 2019, income received less allowable deductible amount is assessable

to retirement rules)

savings

savings

¶16-200 Fixed term income streams Fixed term income streams can be purchased with superannuation or ordinary money. They are payable for a set number of years. The maximum term is generally the number of years remaining until the client (primary owner) reaches age 100. At the end of the term, the income stops. The provider may limit the number of years available in the term to a lower number. Once commenced, fixed term income streams are inflexible products and access to capital may be restricted, subject to the contract requirements. Example Travis is aged 66 and has just retired. He wishes to roll his superannuation money to purchase a fixed term income stream. Travis can choose a term between one to 34 years (ie 34 years remain until he reaches age 100).

Single or joint names Ordinary money income streams can be purchased in single or joint names. Superannuation income streams can only be purchased in the name of the owner of the money. Fewer restrictions apply to ordinary money income streams. Purchasing an ordinary money income stream in joint names allows income splitting for taxation purposes. Upon the death of either party, the survivor has automatic ownership and control of the funds. This removes the need for estates to be finalised before access to these funds is available and may avoid the funds being caught up in any estate disputes. However, it may limit the use of estate planning techniques such as testamentary trusts (¶19-165). Income payments The first year’s income is specified at the time of purchase and is either fixed for the term or indexed at a rate specified in the contract. If it is a superannuation income stream, the SIS regulations specify a choice of two formulae for calculating the minimum income: • a percentage of the purchase price based on the client’s age at commencement and each 1 July (refer to percentage factor tables at ¶16-510) — this is unlikely to be used by providers due to the complexity with guaranteeing income, or • the first year’s income is set and can be varied in future years only in line with an indexation arrangement or upon transfer to a beneficiary. Indexation can be a fixed percentage or be calculated in line with the CPI or average weekly earnings (AWE). Providers who offer a fixed term superannuation income stream are more likely to use the second option. Indexation option Issues such as the term of the contract, life expectancy and future income needs of the client should be assessed to determine if payments should be indexed. Indexation reduces the income paid now to maintain real purchasing power in the future. However, the client may prefer to receive more income now and less in later years if they believe future income needs may reduce. CPI indexation is costly as actuaries often price the income stream based on the worst expected longterm inflation rate. However, it may provide better protection of real purchasing power than a fixed indexation rate. Some pension and annuity providers limit the maximum CPI rate they will cover, while others may pay the lower of the CPI rate or a specified rate. Residual capital value

Income streams are designed to return capital and earnings as income over the specified term; however, fixed term income streams can be structured to have part or all of the capital returned as a lump sum at the end of the contract, rather than as part of the regular income payments. This amount is known as the residual capital value (RCV). A higher RCV results in a smaller income payment as less capital is returned in each payment. An RCV paid from a superannuation income stream is paid as a superannuation lump sum and can be rolled over to start a new income stream, but not if it is paid in certain cases such as death. Death benefits If the client dies before the term expires and the income stream is held in a single name, the income payments may continue for the balance of the term to a reversionary beneficiary or the remaining income stream can be commuted to a lump sum and paid to a dependant or the estate. If held in joint names (non-superannuation) payments continue to the survivor. If purchased with superannuation money, the nomination of a reversionary is limited to a death benefits dependant as defined by tax law. This includes: • a spouse (legal or de facto, and includes same-sex spouse) • child under age 18 or 18–25 in full-time study or who meets the disability requirements • a person who was financially dependent upon the deceased or a person who was in an interdependency relationship with the deceased. A reversionary nomination may allow the beneficiary to receive regular income payments in a tax-effective manner (¶16-910) but transfer balance cap implications may apply (¶16-940). If paid to a child, the income stream must be commuted when that child reaches age 25 unless the child meets disability requirements (¶16-930). The starting income payment to the reversionary can be lower than the amount that was immediately payable to the primary owner, in accordance with the contract terms. Clients suited to fixed term income streams A fixed term income stream provides the advantage of secure income for a known period of time. Payment rates are generally based on fixed interest rates available at commencement (subject to the minimum payment), so in periods of low interest rates the payment rates are also quite low. This means fixed term income streams are generally suitable for clients who do not want to bear investment risk (as with an account-based pension) or who do not want to risk losing capital in the event of a premature death (as could occur with a lifetime income stream). However, clients carry the risk of living beyond the fixed term and using up all funds before their death, that is, longevity risk.

¶16-250 Investment security of fixed term income streams Once the fixed term income stream contract is signed and the investment made, the payments and any residual capital value are generally guaranteed to the client for the agreed term. These guarantees reduce market risk but the guarantees are only as good as the company providing them. These risks are lessened by: • government supervision through the Australian Prudential Regulation Authority (APRA) • investment backing by the life office statutory funds, which requires mandatory reserves to ensure obligations can be met now and in the future (to date, no life insurance statutory fund has collapsed in Australia). The majority of assets supporting income streams are secure, long-term, income-producing investments. It is the role of the provider’s chief actuary to ensure the policies are priced appropriately and the company follows a secure investment strategy.

¶16-260 Advantages and disadvantages of fixed term income streams Advantages

Disadvantages

– provides regular guaranteed income for a fixed number of years

– income payments will be low if started in periods of low interest rates

– can be purchased with ordinary or superannuation money

– once commenced, changes cannot be made to options

– client does not carry the market risk from underlying investment performance

– no ability to vary income outside contractual arrangements (ie limited to agreed indexation rate)

– if purchased before 20 September 2007, it may have exemptions for social security/veterans’ affairs and aged care purposes

– client is taking some longevity risk as they may live longer than the selected term

– payments can be indexed to maintain real value

– generally does not allow access to lump sum withdrawals

– a death value is payable to the estate — calculated as the current value of the remaining income payments, commuted to a lump sum

– if commenced with superannuation money the value is assessed against the transfer balance cap to restrict the total amount in superannuation income streams

¶16-300 Lifetime income streams Lifetime income streams can be purchased with superannuation or ordinary money. Lifetime income streams pay a regular income to the client for their life, or if purchased with ordinary money for the life of the last surviving joint owner. If a reversionary beneficiary is nominated in the contract (¶16-330), upon the death of the original owner payments continue to the reversionary recipient for the rest of their life. A lifetime income stream has the advantage of simplifying investments and provides security through guaranteed income. Lifetime income streams eliminate longevity risk for the client as they will not outlive their money. However, the guaranteed income may be insufficient to fully meet the client’s needs. In SMSFs, the poor performance of underlying investments may lead to the trustee being unable to pay the agreed income stream for the member’s lifetime, so some longevity risk is still assumed in SMSFs. SMSFs are not able to commence new lifetime pensions unless purchased from an external life company. Once commenced, lifetime income streams are inflexible products and access to capital is likely to be restricted. The contract specifies the conditions of payment and cannot be varied. Most contracts allow commutations within the first six months, unless specific circumstances apply. Once this period has expired the client usually cannot make lump sum withdrawals or cancel the policy. The contracts can be tailored before commencement to suit the current and future needs of an individual client. Each option has an effect on the income as the responsibility and risk to the trustee or the life insurance company may increase, resulting in lower income payments. It is vital that the implications of the various options are considered and weighed up to determine the value to the client and the effect on income produced. Lifetime income streams generally do not offer a residual capital value although some newer products developed may offer guaranteed death benefits and withdrawal values. Joint or single names Lifetime annuities purchased with ordinary money can be purchased in either joint or single names. Superannuation lifetime income streams can only be purchased in the name of the client who owns the superannuation money. The implications are the same as for fixed term products (¶16-200). Income payments

Income payments continue for the life of the client and reversionary beneficiary (if selected) in accordance with the contract. The income payments need to either: • be set at commencement and only vary in line with a fixed percentage, CPI or average weekly earnings (AWE), or • pay a minimum income each year based on a formula as shown below. The minimum income under the second option above is calculated as: purchase price × percentage factor* * Uses the same percentage factor as account-based income streams at ¶16-510.

The minimum income payment is rounded to the nearest $10. The income payment is pro-rated in the first year for the number of remaining days. The income payments in subsequent years can only vary due to an annual indexation arrangement. Providers are unlikely to use the formula method due to the complexity with guaranteeing the income payments for life. Indexation of income If agreed under the contract, the income payable from a lifetime income stream can be indexed. The implications for this decision are the same as for fixed term products (¶16-200). Guarantee period and death benefits A guarantee period is a minimum payment period and provides insurance against a large loss of capital due to an early death. It is usually an optional feature and may result in a lower income payment if selected than if not selected. Quotes with and without a guarantee period can be obtained to weigh up the costs involved. Many people choose to have a guarantee period to minimise the loss resulting from premature death, particularly if a member of a couple although nomination of a reversionary can be an alternative. If the client dies during the guarantee period and has not nominated a reversionary, the remaining guaranteed income stream will be converted to a lump sum. If a reversionary beneficiary has been nominated, the guarantee applies where both people die before the end of the guarantee period. The guarantee period for non-commutable income streams cannot exceed the lesser of the client’s statistical life expectancy (as determined by the Australian Life Tables at ¶20-250) or 20 years. Choosing a longer guarantee period may increase protection against loss of capital, but may come at the cost of lower income payments.

¶16-330 Reversionary nominations on lifetime income streams If purchased with superannuation money, an election can be made to have payments continue to a nominated reversionary beneficiary. The nomination of a reversionary is limited to a death benefits dependant as defined by tax law. This includes: • a spouse (legal or de facto, and includes same-sex spouse) • child under age 18 or 18–25 in full-time study or who meets the disability requirements • a person who was financially dependent upon the deceased or a person who was in an interdependency relationship with the deceased. A reversionary nomination may allow the beneficiary to receive regular income payments in a tax-effective manner (¶16-910) but transfer balance cap implications apply (¶16-940). If paid to a child, the income stream must be commuted when that child reaches age 25 unless the child meets disability requirements. The starting income payment to the reversionary can be lower than the amount that was immediately payable to the primary owner, in accordance with the contract terms.

Selecting a lower reversionary payment results in a higher income level during the owner’s lifetime. Income needs now, and in the future, should be considered to determine the best strategy for the client. A reversionary nomination may allow the beneficiary to receive regular income payments in a tax-effective manner (¶16-910).

¶16-360 Advantages and disadvantages of lifetime income streams Advantages

Disadvantages

– provides regular income guaranteed for life, so the client takes no longevity risk

– income payments will be low if started in periods of low interest rates

– can be purchased with ordinary or superannuation money

– once commenced, changes cannot be made to options

– client does not carry the market risk from underlying investment performance

– no ability to vary income outside contractual arrangements (ie limited to agreed indexation rate)

– depending on purchase date and features, advantages may be obtained for social security/veterans’ affairs and aged care purposes (individual comparisons required)

– death value may only be payable within guarantee period — therefore, early death may result in a large capital loss

– income can be indexed to maintain real value

– generally cannot be commuted – access to cash as lump sum withdrawals is not allowed (if non-commutable) – if commenced with superannuation money the value is assessed against the transfer balance cap to restrict the total amount in superannuation income streams

¶16-400 Term allocated pensions (TAPs) Term allocated pensions (TAPs) were introduced on 20 September 2004 as a new category of complying income stream. Legislation refers to them as market linked income streams (MLIS). They were essentially introduced to gain access to the pension RBL and social security asset test exemptions, but with a market-based return. However, with the changes in both areas of concessions these income streams have generally not been available for new purchases from 20 September 2007, except for limited rollover of existing TAPs. Term allocated pensions can only be purchased with superannuation lump sums. They cannot be purchased with ordinary money unless that money is first contributed to superannuation. Each investor has an identifiable account which is allocated to the investor but lump sum withdrawals are not allowed and income payments have limited flexibility. Investment returns are added to the account (or subtracted if the investment makes a loss) and regular income payments and fees are deducted. Term allocated pensions are non-commutable (with limited exceptions) and have no residual capital value at the end of the term. The income is payable for a fixed term based on life expectancy. Details on calculation of the term are explained at ¶16-830. Unlike traditional complying income streams (ie lifetime and fixed term income streams) (¶16-830), term allocated pensions do not provide a guaranteed income stream. The investor can select a portfolio of underlying investment options, including growth investments. The income payment each year is based on the account balance, which is impacted by investment performance. The income payment can rise or fall each year. As income payments are linked to investment market returns, they provide the potential for a higher income return than traditional complying income streams. However, the client takes the investment risk.

They also take on longevity risk due to the fixed term. Upon death of the owner, the income stream can continue to a reversionary (death benefits dependant) or the remaining account balance can be paid as a lump sum death benefit. If the term is based on the nominated reversionary’s life expectancy, commutation to pay a lump sum death benefit is only allowed upon the death of both the original owner and the reversionary. Structured as complying for RBL purposes Term allocated pensions could be structured to meet the complying standards for RBL purposes (purchased before 1 July 2007) or a 50% asset test exemption for social security (purchased before 20 September 2007) (¶16-830). RBLs have been abolished, but the 50% asset test exemption (for social security and aged care purposes) will continue to apply if the income stream was purchased before 20 September 2007. Complying income streams are non-commutable. Despite the fact that RBLs have been abolished from 1 July 2007 so the concept of a complying income stream no longer exists for taxation purposes, existing income streams remain non-commutable. They can only be commuted in limited circumstances if the money is rolled over to another comparable and non-commutable income stream (¶16-840).

¶16-410 TAP income payments The annual income payment is calculated by dividing the account balance at commencement and each 1 July by the payment factor (PF) for the remaining term as contained in SIS regulations. The regulations list the terms in whole numbers, so rounding of the actual term remaining is required. Annual payments are rounded to the nearest $10 (refer to the table at ¶20-270 for PFs). In the first year, the income payment is pro-rated. If the pension commences on or after 1 June, no payment is required in that financial year. In the last year, the entire remaining balance is paid as income. The client can choose to vary the annual income received up or down from the calculated amount by 10% (if allowed by the provider). For example, if the income payment was calculated on 1 July as $10,000, the client could choose to receive between $9,000 and $11,000.

Note For the 2019/20 and 2020/21 financial years, the minimum income payment is halved to help clients through the COVID-19 crisis. This means that the minimum payment for these years must not be less than 45% of the standard minimum payment (allows for the standard 10% variation). Example Chris (aged 65) is married to Kristy (aged 62). He purchased a term allocated pension for $120,000 on 1 August 2007, with Kristy nominated as reversionary. Chris could choose a term: – between the life expectancy of a 65-year-old male (ie 18 years) and the number of years remaining to age 100 (ie 35 years), or – between the life expectancy of a 62-year-old female (ie 24 years) and the number of years remaining for Kristy to age 100 (ie 38 years). Note: All life expectancies are rounded up to the nearest whole number. Chris chose a term of 30 years. The income payment for the first year was calculated by dividing the account balance by the PF (¶20-270) applicable for a remaining term of 30 years (ie 18.39). Therefore, the first year’s income was $120,000/18.39 = $6,530 (rounded to nearest $10). The income stream commenced part-way through the financial year so the income payment is pro-rated for the 2007/08 financial year to $4,350. On 1 July 2008 the annual income was recalculated. At that point, the income stream had been running for eight months, so the remaining term was 29.33 years. This needed to be rounded to determine which PF to use. If the income stream was originally purchased before 1 January, the remaining term is rounded down. If the income stream was purchased on or after 1 January, the remaining term is rounded up. Chris purchased the income stream on 1 August 2007, so on 1 July 2008 the remaining term of 29.33 years was rounded down to 29 years. The PF to be used is that for a remaining term of 29 years (ie 18.04). If the balance on 1 July 2008 had grown to $125,000, the income payment for the 2008/09 financial year was $125,000/18.04 = $6,930 (rounded to nearest $10). On 1 July 2009 the applicable PF was for a remaining term of 28 years, and reduces each subsequent year. The term is due to expire on 31 July 2037 (ie 30 years from the date of commencement). In the last year, the remaining balance is

payable as income. However, there are some complexities in determining when the actual income payments will end and this will depend on how the TAP is set up by the product provider. In this example, when the income payment is calculated on 1 July 2036, the term remaining is 16 months, but the term is rounded down to determine the PF. Therefore, the PF is for one remaining year which is a PF of one. This would require the account balance to be fully paid out as income in that financial year (ie by 30 June 2037), which is four months before the end of the term. Alternatively, the provider could choose to set their systems up so that the final payment is paid over the full remaining term of 16 months. As the income payments were determined on the balance at 1 July 2036, at the end of the 16 months (ie 31 October 2037) when the term ends, there may still be some balance remaining due to accumulated earnings in the account. The product provider needs to pay this amount out within 28 days. The payment is a non-assessable lump sum for Centrelink purposes.

¶16-440 Advantages and disadvantages of term allocated pensions (TAPs) Advantages – provides income for a set number of years

Disadvantages – limited ability to vary income each year

– met criteria to receive asset test exemptions for – no access to cash as lump sum withdrawals social security purposes and aged care purposes if purchased before 20 September 2007 (or purchased after that date from full commutation of a complying TAP) – upon death, remaining account balance is paid to – client is taking some longevity risk as they may dependants or estate live longer than the selected term – potential to earn higher income than other complying income streams due to market rates of return

– client carries the market risk from underlying investment performance and this will result in a variable income stream each year – cannot be purchased with ordinary money (unless able to contribute to super) – balance counts against the transfer balance cap to restrict the total that can be invested in superannuation income streams

¶16-500 Account-based pensions Account-based pensions were previously called allocated pensions. Each client has an identifiable account which is “allocated” to them. Investment returns are added to the account (or subtracted if the investment makes a loss) and regular income payments, fees and withdrawals are deducted. Income payments continue until the account balance is exhausted. Account-based pensions offer the greatest flexibility but the client is accepting the investment and longevity risks. For some clients it may be prudent to combine an account-based pension with a lifetime or fixed term income stream that provides income to meet basic living expenses with greater certainty. A new breed of account-based pensions is emerging with lifetime guarantees on certain amounts of income (¶16-570). An account-based pension can commence at any age provided a condition of release has been met (including the transition to retirement rules, although the tax-free rules for earnings do not apply if commenced under these rules (¶16-585) as a transition to retirement pension does not qualify as a retirement income stream). This type of income stream can only be purchased with superannuation money. Ordinary money would first need to be contributed to super (if eligible) and then rolled over to purchase the account-based pension. Once an account-based pension has commenced, further money cannot be added to the account but would need to be used to set up a second account-based pension. Longevity risk

Clients take on market risk as well as longevity risk with an account-based pension. How long the income is paid depends on the investment performance of the fund and the amount chosen to be withdrawn each year. Account-based pensions usually offer a choice of investment options. The selected options should match the client’s risk profile with regard to the expected investment timeframe (ie life expectancy). It is becoming more important to understand and manage longevity risk now that clients aged 60 years or over can withdraw any amount tax-free with no maximum income limits and life expectancies are increasing. Clients need to understand how long their account-based pension is projected to last to determine how much they can afford to withdraw each year. Death benefits The account balance remaining upon death is paid as a death benefit. If the trust deed allows, the income stream can continue to a death benefits dependant (as defined by taxation law) or it can be commuted to a lump sum and paid to either an SIS dependant or the estate. If paid to a child, the pension must be commuted before the child reaches age 25 unless the child meets disability requirements.

¶16-510 Account-based pension income limits A minimum level of income must be paid each financial year from an account-based pension. This is determined as a percentage of the account balance. If the minimum payment is not paid, the ATO will deem the account to have been in the accumulation phase for the whole year and tax is therefore payable on the underlying earnings. The client can change the level of income each year to suit changing requirements. The frequency of payments can also be selected to match the client’s needs. Minimum pension payment The minimum payment in the first financial year is a percentage of the account balance at commencement and is pro-rated for the remaining number of days in that year. If the income stream starts in June, a minimum payment is not required for that financial year. In subsequent years, the minimum payment is a percentage of the account balance as at 1 July. Once calculated, the minimum income is fixed for the entire financial year regardless of any changes in account balance during the year. If a client plans to withdraw a lump sum from the income stream, consideration may be given to withdrawing the amount before the end of the financial year, rather than early in the next year. This allows the income limit for the next year to be based on the reduced account balance to calculate a lower minimum. Percentage factors The minimum payment is calculated using the percentage factors specified in the SISR. The percentage factors are based on the person’s age and the percentages increase as the person gets older. The formula used to calculate the minimum income payment is (with amounts rounded to the nearest $10): Account balance × Percentage factor The table below shows the standard percentage factors for account-based income streams (commenced on or after 20 September 2007). As a result of COVID-19, the minimum payment amounts for accountbased pensions (and for the equivalent annuity products) were reduced by half for the 2019/20 and 2020/21 financial years (The Coronavirus Economic Response Package Omnibus Act 2020, Sch 10). Age of beneficiary

Reduced percentage factor for 2019/20 and 2020/21

Standard percentage factors

Under 65

2%

4%

65–74

2.5%

5%

75–79

3%

6%

80–84

3.5%

7%

85–89

4%

9%

90–94

5.5%

11%

95 or older

7%

14%

Allocated pensions (as they were known) which started before 1 July 2007 applied a minimum and maximum payment using different sets of factors (refer to tables at ¶20-260). However, from 1 July 2007 the provider (including an SMSF) could choose to switch to the new set of factors for these income streams but this should be clearly documented in fund records. Public offer funds are all likely to have switched to the new rules and so would most (if not all) SMSFs. The standard factors shown above apply to all account-based pensions commenced on or after 20 September 2007. If the income stream started between 1 July 2007 and 19 September 2007, the provider could choose to use the above factors or the factors that existed before 1 July 2007 (refer to tables at ¶20-260). Example Bob is aged 65 and commences an account-based pension on 1 July 2020. His account balance is $100,000. Bob’s minimum income payment for the year is calculated as follows:

Minimum

= $100,000 × 2.5% = $2,500

If he commences the pension on say 1 October 2020, the minimum payment is pro-rated to $2,500 × (9/12) = $1,875. If he commences the pension on 1 June 2021, he does not need to take any pension payments for 2020/21.

Maximum pension payment Account-based pensions started on or after 20 September 2007 (or that converted to the new tables) are not limited by a maximum income amount, unless paid under the transition to retirement rules (¶16-585). The maximum annual payment from a transition to retirement pension is 10% of the account balance at commencement and each 1 July. The maximum is not pro-rated in the year of commencement. Account-based (allocated) pensions which started before 20 September 2007 were subject to a maximum income payment up to age 80. But if the pension converted to the new minimum factors, a maximum no longer applies. Example Bob (from the example above) has a maximum income payment for the year equal to his available account balance, ie $100,000.

¶16-520 Impact of commutations from an account-based pension Lump sum withdrawals (commutations) can be made from an account-based pension at any time unless it is a non-commutable pension started under the transition to retirement rules. Withdrawals above the 10% limit for a transition to retirement pension cannot be made until a full condition of release has been met and the money becomes fully accessible (unrestricted non-preserved). Taxation and social security

Commutations are treated as superannuation lump sums. They will be split between taxable and tax-free components according to the split that applied when the income stream commenced (¶16-710). No tax is payable if the client is aged 60 or older. If the client is under age 60, lump sum tax may apply on the taxable component. A commutation may reduce the non-assessable income portion for social security/veterans’ affairs/aged care purposes if the pension is assessed under the grandfathered deductible amount rules. Minimum income If a partial commutation is requested from an account-based pension, the provider needs to ensure there is enough remaining in the account to pay the outstanding minimum payment for the year. A pro-rated income minimum payment must be paid if an account-based pension is fully commuted during a financial year. Therefore, part of the commutation may be paid as income and the balance as a superannuation lump sum. Example Jose started an account-based pension when he retired four years ago. On 1 July 2020, his account balance was $485,000 and he was 69 years old. His minimum income payment for 2020/21 is $485,000 × 2.5% = $12,125. Jose is receiving quarterly income payments at the minimum level. This equals $3,031.25 on the last day of each quarter. On 1 November he decides to commute the account-based pension and rollover to a new provider. The pro-rata minimum payment required for the year to date (1 July–31 October) is $4,041.67 (ie $12,125/12 × 4 months). So far, he received an income payment of $3,031.25 on 30 September. Therefore, upon commutation a further income payment of $1,010.42 ($4,041.67 − $3,031.25) is required to be paid. The new provider will be required to calculate a pro-rated minimum payment for the rest of the year based on the balance used to commence the new account-based pension.

¶16-540 Advantages and disadvantages of account-based pensions Advantages

Disadvantages

– ability to vary income each year (must take at least the minimum)

– no asset test exemption for social security

– access to lump sum withdrawals is allowed

– client takes longevity risk as income payments stop when the account balance runs out

– upon death, the remaining account balance is paid to dependants or estate

– client takes the market risk and poor performance will shorten the life span of the income stream

– potential to earn higher income than other income streams due to market rates of return

– cannot be purchased with ordinary money (unless able to contribute to super)

– if qualify for Social Security deductible rules (due – amount that can be used to commence pension to grandfathering) this may result in lower income is restricted by the transfer balance cap than deeming (depends on circumstances). This may help to maximise Age Pension and reduce aged care fees

¶16-570 Longevity income streams and CIPRs Recent years have seen significant discussion over changes required for income stream products to more effectively help clients manage longevity risk. Product development has been limited by the strict requirements needed to qualify for the income exemption on earnings that are used to support pensions. Several longevity income stream products have been released into the Australian market over the last decade that offered various forms of longevity solutions. These income streams had varying structures

and features but generally used a combination of an account-based pension for the early retirement years with a deferred income stream that commences in the latter years of retirement when the account balance runs out. The deferred income stream has been structured through pooling of mortality risk or other capital protection mechanisms. However, many of these products were not successful due to the legislative restrictions and the inability to access the taxation exemptions on earnings. The new Regulations and further recent changes may see new products developed and introduced into the market which are more successful. Deferred superannuation income streams The Treasury Laws Amendment (2017 Measures No 1) Regulations 2017 allow new innovations in retirement income streams from 1 July 2017. This introduces a new SIS Regulation reg 1.06A which provides a definition of a deferred superannuation income stream. The new design rules for lifetime income streams contained in the Regulations will allow the development of: • deferred products • investment-linked income streams, and • group self-annuitised products. The new Regulations require the income to be payable for the person’s lifetime but income payments can be guaranteed by the income stream provider or be determined either by returns on a collective pool of assets or the mortality experience of members of the asset pool. The product can provide a deferral period before payments commence and commutations can be allowed, subject to a declining capital access schedule and preservation rules. A new condition of release will allow a deferred income stream to be purchased from preserved or restricted non-preserved benefits. Changes to social security legislation from 1 July 2019 may encourage the development of these income streams. Comprehensive Income Products for Retirement (CIPRs) A CIPR is an emerging category of retirement income products which will be designed to: • provide regular and consistent retirement income • manage longevity risk through lifetime income, and • still allow some access to capital for flexibility. Legislation has not yet been introduced (as at time of writing) to introduce this category. Under the Retirement Income Covenant (¶16-135), if legislation is passed, superannuation fund trustees will be required to offer members the opportunity to roll accumulated superannuation savings into a CIPR from 1 July 2022 (or earlier if desired). This can be a product offered internally or developed and offered by an external provider. Based on the discussions to date, the concept of a CIPR is broadly an account-based pension with a lifetime annuity attached. In previous years this has been referred to as a longevity income stream. This combination provides a lifetime income stream but allows a more market approach to aim for a better investment return. The trustee does not have to provide guarantees on the CIPR. While the annual payments need to be regular and constant, variation may occur from year to year due to variation in investment returns and longevity outcomes. The trustees need to manage the underlying investments with an expectation of maintaining broadly constant income in either real or nominal terms (as selected). This expectation could also take into account the interaction with age pension entitlements to provide a constant overall income. It is proposed that a CIPR needs to be designed to provide income for the member’s full lifetime. This

requires inclusion of a pooled lifetime income product which can be either an immediate or deferred lifetime income stream that allows the client to continue to receive broadly the same level of income for life. It is expected that members selecting a CIPR would need to invest roughly 15-20% of their money into this lifetime component but will depend on the pricing and structure set by the trustee. The CIPR needs to allow the option to nominate a reversionary pensioner. While trustees will need to offer a CIPR as the flagship retirement offer (if legislation is passed), members will not be compelled to accept a CIPR. They will continue to have the choice to invest fully into another retirement income stream (including a traditional account-based pension) or to cash out their benefits as a cash lump sum. If the trustee has reliable information in relation to a member that determines a CIPR is not appropriate they will not have to offer a CIPR. This might include situations such as where the member has: • a terminal illness • only small superannuation savings, for example, less than $50,000. Changes to social security income stream assessment rules for lifetime income streams purchased from 1 July 2019 allow for the introduction of deferred income streams and CIPRs. These rules have been passed in legislation and are discussed at section ¶16-593.

RETIREMENT PORTFOLIO CONSTRUCTION ¶16-575 Making income stream payments Pension payments must be made as cash payments. They cannot be paid as in specie asset transfers. This also applies to income payments from death benefit pensions.

¶16-580 Retirement portfolio strategies When developing retirement portfolios for clients it may be useful to consider a combination of income streams to meet the various needs of clients. In particular, this needs to take into account a client’s need or desire to secure their base income needs through more secure and guaranteed options such as lifetime annuities (¶16-300). The needs of a client in retirement are obviously different than the needs of a client during working years as they will have moved from wealth accumulation to wealth de-accumulation (or drawdown). However, this does not mean that the client does not need to consider growth strategies, as growth is still needed to manage longevity and inflation risks. When making recommendations on retirement income strategies not only is it important to consider which products will meet a client’s needs, but it is also important to consider the strategy for where income will be drawn from. There are different portfolio construction strategies that are recommended and used by various advisers. Analysing an appropriate recommendation for clients will depend on the forecast for: • future interest rates and earnings growth • risk management views and priorities • active versus passive management approach, and • potential life expectancy of the client. Two commonly used strategies are discussed in this section. Whatever strategy is used, it is important to understand that the amount that can be used to purchase superannuation income streams is limited by the transfer balance cap (¶16-155).

Income layering The income layering approach is aimed at managing longevity risk to create certainty for basic income needs throughout the client’s lifetime. Under the income layering approach, it is assumed that the client’s base (non-discretionary) income needs are met through Centrelink/Veterans’ Affairs payments and lifetime or term certain annuities. This provides certainty to meet this income, and indexation can be included. The discretionary (or lifestyle) income is then met through the use of an account-based pension (or other market-related investments) which allows flexibility for drawdowns each year and may also allow investment in more growth-orientated assets. It is often assumed that discretionary income needs are higher during the earlier years of retirement when a client has a greater desire to focus on lifestyle and entertainment and that income needs fall in later years. However, the costs of providing for aged care in later years should not be overlooked. Choosing the type of care to achieve quality of lifestyle may require an increasing level of expenditure during the later “frailty years” of life. Bucket approach The bucket approach is aimed at managing market volatility to help maximise the length of time that the client’s savings will last. It particularly aims to manage the implications of a market downturn early in the retirement phase. Under this approach, the: • client’s income needs for the first few years (generally 2–3 years) are invested in capital secure options (ie cash and short-term fixed interest) • income needs for the following few years (generally another 2–3 years) are invested in longer term fixed interest options (ie bonds and term deposits) • balance of savings is invested for growth (ie shares and property). The income is successively drawn from the capital secure bucket, then the fixed interest bucket and lastly from the growth bucket. As an alternative to this strategy, which depends on the strategy and outlook for market performance, as the capital secure bucket is depleted, it may be topped up from the other buckets so that income is always drawn from the capital secure bucket. This option aims to ensure that if markets perform poorly in early years the client will be able to draw down from the cash investments and leave the growth investments intact to recover from the market downturn. It should be noted that if the growth assets perform well during that initial period, this strategy may underperform a strategy with a higher growth component.

¶16-585 Transition to retirement rules A person who has reached their preservation age but is still working either full-time or part-time (so does not trigger a full condition of release) can commence a non-commutable income stream using preserved superannuation benefits. This may include a non-commutable account-based pension — called a transition to retirement pension. The aim of this legislation is to allow people who reduce working hours the opportunity to start an income stream to top-up their reduced income, thereby encouraging greater workforce participation by older Australians. However, the legislation has also been used by people who are still working full-time to maximise their retirement savings by using taxation advantages from salary sacrifice or personal deductible contributions. Changes from 1 July 2017 have made the tax strategies less effective. The transition to retirement pension remains non-commutable until a full condition of release has been

met and a request is made to the trustee to convert it to a fully accessible income stream. Even though the income stream is non-commutable, the account value of a transition to retirement pension is fully assessable under the social security/veterans’ affairs asset test. A transition to retirement pension can be stopped and rolled back into the accumulation phase of superannuation (as preserved money) if the client’s plans change. Income payments If the client commences a transition to retirement pension, the client can choose an income payment between the required minimum payment for a normal account-based pension (ie 4% for a person age 55– 65) (¶16-510) and the maximum payment limit for the financial year which is equal to 10% of the account balance at commencement and then each 1 July.

Note For 2019/20 and 2020/21, the minimum income payments have been halved to help clients through the COVID-19 crisis. The maximum payment remains at 10%. In the first year, the minimum income is pro-rated for the number of remaining days in the year but the 10% maximum is not pro-rated. If the minimum income payment is not paid, the ATO will consider that a pension does not exist and the money has been in the accumulation phase of superannuation for the full financial year. As well as then having tax applied to the earnings in the fund, this may cause problems with illegal early release of superannuation as the amounts withdrawn are considered to be accumulation lump sums from preserved money. Benefit for clients needing more income The initial aim of the transition to retirement pension legislation was to allow clients who are reducing work hours to top up income. The example below shows how a transition to retirement strategy can help a client transition to part-time work. Refer to the strategy at ¶16-610 for details on how a transition to retirement strategy has been used by a client still working full-time. Example Hillary is aged 57 and was made redundant in June 2020. She cannot find full-time work, but has been offered a part-time job for 15 hours per week. The income from this job is not enough to meet her needs, but despite being over preservation age, as she has not permanently retired (she is working more than 10 hours a week) she cannot meet a condition of release to access her superannuation money. Hillary can use the transition to retirement provisions to roll some or all of her super into a non-commutable account-based pension to top up her income. She is not able to make any lump sum commutations, and she is limited to drawing an income equal to 10% of the account balance each year. It is not a retirement phase pension so the tax exemptions on earnings do not apply and it is not counted against the transfer balance caps. Hillary rolls $300,000 into the non-commutable account-based pension on 1 July 2020, so she can choose an annual income between $6,000 ($300,000 × 2%) and $30,000 ($300,000 × 10%). If she starts part-way through the year, the minimum payment, but not the maximum payment, is pro-rated. The income stream balance is assessable under the asset test if she applies for Centrelink of Veterans’ Affairs benefits and the income will be captured under deeming rules. Hillary will pay tax on the income payments until she reaches age 60. When she reaches age 63, Hillary decides to stop working and fully retire. This triggers a condition of release and it can become a retirement phase pension. At that point it is assessed against the transfer balance cap. The earnings become tax-free and the noncommutable restriction is removed so she has unlimited access.

Taxation of transition to retirement pensions and the transfer balance cap From 1 July 2017, a transition to retirement pension is not considered to be a retirement phase income stream until a full condition of release is met (ATO Guidance Note 2019/1). Therefore, the earnings generated on assets used to support a transition to retirement pension are taxed in the fund at 15% (same as accumulation phase). This applies even if the pension was commenced before 1 July 2017. The change in tax rules from 1 July 2017 reduced the tax effectiveness of transition to retirement pensions and this strategy has become less popular.

While the taxation of earnings in a transition to retirement pension may reduce the strategic advantages for clients who are still working full-time, a transition to retirement pension may still have strategic advantages for clients who: • are reducing working hours and need to generate top-up income • wish to increase disposable income (using preserved superannuation savings), for example to meet living expenses or pay off debts • want to nominate an automatic reversionary for estate planning purposes. The transition to retirement pension is not assessed against the transfer balance cap (¶16-170) until the client reaches age 65 or notifies the trustee that a full condition of release has been met and it converts to a retirement phase pension.

¶16-587 Generating income from other investment options If a client does not have superannuation benefits or an income stream product does not meet their needs, regular income can be generated from other investment options. These options will provide their own advantages and disadvantages. Even if an income stream is used, it may be appropriate to include other investment types in a financial plan for diversification. Some examples of other options are included below. Fixed interest: Provides secure regular income with a range of terms. Income payments usually comprise only investment earnings while capital may be accessible only on maturity. Inflation protection is not usually built into the income stream payments. Fixed interest investments are generally not tax effective and may be subject to Pay As You Go (PAYG) tax instalments. Income-producing property: Income can grow with inflation. Property assets are illiquid investments as large amounts of capital are tied up. Equity investments (shares): Dividends from franked shares provide tax advantages to investors. Imputation credits can be used to offset tax on other income. Excess franking credits can be refunded in cash. This may make franked shares attractive for low-income earners. The tax rules for superannuation may make non-superannuation investments a less attractive alternative. Income and capital gains from non-superannuation investments will remain taxable, while benefits paid from a (taxed) income stream are tax-free from age 60. Clients may therefore wish to contribute non-superannuation money into superannuation (subject to contribution limits and restrictions). However, note that as the superannuation income payments are no longer taxable income from age 60, a client can also receive certain amounts of income outside superannuation without any tax payable. Income stream products need to be considered within the context of the total financial plan to ensure all resources are used most efficiently. Example A person who is under age 60 can earn taxable income from a superannuation income stream of around $55,450 in 2020/21 and pay no tax if this is the only source of income (Medicare levy may, however, be payable). Non-superannuation income may create a taxation liability.

  Taxable income

$55,450

  Tax payable

$9,567 (excluding Medicare levy)

  Less: 15% offset

$8,318

  Less: low income offset

$169

  Less: low and middle income tax offset $1,080

Non-superannuation income of the same amount may create a taxation liability up to $8,318 (plus Medicare) as the 15% offset is not available. Income from a taxed income stream is not assessable income for a person aged 60 or older. This allows a person between age 60 and Age Pension age to earn taxable income of $21,884 from other nonsuperannuation sources before any tax is payable. A person who is over Age Pension age or qualifies for pension benefits from Centrelink/Veterans’ Affairs may qualify for the senior and pensioner tax offset (SAPTO) as well as the low income tax offset and the low and middle income tax offset (¶1-055). This can allow the person to earn even higher amounts from non-superannuation sources and pay no tax.

¶16-589 Income splitting Splitting investments, and therefore income, allows both partners of a couple to take advantage of the taxfree threshold and progressive tax scales to reduce total tax payable. Superannuation withdrawals as lump sums or income (from a taxed source) are tax-free from age 60 so splitting may not provide much advantage from a personal taxation point of view while both members of the couple are still alive. However, as the transfer balance cap (¶16-170) limits how much each person can rollover to start a retirement phase income stream (general transfer balance cap is $1.6m in 2020/21) for tax-free fund earnings splitting may help to even out balances so the couple has the opportunity to maximise the total amount in income streams. Splitting investments can also enable each person to have some control and provide estate planning benefits or may provide some protection if tax rules are changed in the future to reapply tax to income streams. Withdrawals as lump sums or income Superannuation money can only be used to purchase an income stream in the name of the owner. Before starting an income stream, it may be worth considering splitting superannuation benefits with the spouse through a cash-out and spouse (or personal) contribution strategy (¶15-190) if the spouse is eligible to contribute to super. Alternatively, super could be accumulated in both partners’ names on a progressive basis using contributions in each name or the superannuation contribution splitting rules each year. Preservation issues and the impact on Centrelink benefits should be considered.

SOCIAL SECURITY AND AGED CARE ASSESSMENT ¶16-590 Social security and aged care assessment The Social Security assessment rules have undergone a number of changes over the last 20 years and depend on date of purchase and type of income stream purchased. The rules for lifetime income streams have changed significantly on several occasions — 20 September 2004, 20 September 2007 and 1 July 2019. The first two changes affected the assessable asset value. The most recent change affects both assessable income and assessable assets. The same rules apply for Social Security (and Veterans’ Affairs) and for means testing of aged care (both residential care and home care packages). Strategies to maximise social security with income streams can be found at ¶16-620 and strategies to minimise aged care fees at ¶16-630. Social security in general is also discussed in more detail in Chapter 6. Veterans’ Affairs means testing rules are usually the same as Social Security.

¶16-591 Account-based pension assessment Assets test assessment

Under the assets test, account-based pensions (including transition to retirement income streams) have the full account balance included as an assessable asset. Income test assessment Under the income test, account-based pensions purchased from 1 January 2015 are counted as financial investments and assessed under the deeming rules. Account-based pensions commenced before 1 January 2015 are assessed under the deductible amount rules (¶16-598) provided the client meets the grandfathering requirements. To meet the grandfathering rules the client needed to be in receipt of a means-tested or blind pension as at 31 December 2014 and continuously received an income support payment since that date. The income assessment may switch to deeming rules: • If the client was not in receipt of a means-tested or blind pension as at 31 December 2014 or subsequently loses eligibility. • If the account-based pension was purchased before 1 January 2015 but is commuted and rolled over to a new account-based pension after 31 December 2014. Example Patrick started an account-based pension on 4 July 2014. At the same time, he applied and qualified for an Age Pension and has continued to remain eligible for an Age Pension. His account-based pension continues to be assessed under the Centrelink income test using deductible amount rules provided he remains continuously in receipt of an Age Pension and does not commute the account-based pension to start a new pension. Damien receives an Age Pension and has an account-based pension assessed under deductible rules. But on 14 March 2021, he commutes this account-based pension and rolls it to a new pension within an SMSF. Damien’s new account-based pension will be assessed under deeming rules. Alice has an account-based pension that she commenced in 2010. She is married and receives a part Age Pension. When her husband passes away in June 2020, she is assessed as a single person and loses her Age Pension. She restructures her finances and reapplies for an Age Pension in December 2020. She has continued the same account-based pension but because she lost eligibility for the Age Pension, it will now be assessed under deeming rules.

¶16-592 Fixed term income stream assessment The same rules apply to superannuation and ordinary money fixed term income streams. The rules for fixed term income stream that meet the complying rules are discussed at ¶16-830. Assets test If the fixed term income stream is purchased on or after 20 September 2007 (or before that date but does not meet the rules to be a complying income stream — discussed at ¶16-830), the full purchase price is initially assessable as an asset. This asset value is then reduced each six months by any return of capital, as determined by the calculated deductible amount (¶16-598) for income payments that have been paid over that six-month period. If income payments are only made annually, this reduction will occur once a year when the income payment is made. Income test Under the income test: • if the term is longer than five years, the deductible rules apply • if the term is five years or less but still longer than the client’s statistical life expectancy, the deductible rules apply • if the income stream has a term of five years or less, and this term is shorter than the client’s statistical life expectancy, deeming rules will apply. Details on the deductible rules are at ¶16-598.

¶16-593 Lifetime income stream assessment Non-commutable defined benefit pensions are assets test exempt but other lifetime income streams (both superannuation and ordinary income) are assessable. Lifetime income streams purchased before 20 September 2007 may have met the complying income stream rules to qualify for significant assets test advantages. Refer ¶16-830 on complying income streams. For strategies for Centrelink/DVA with income streams, refer ¶16-620. Definition of pooled lifetime income stream From 1 July 2019, the concept of a pooled lifetime income stream was introduced. This aims to cover flexibility for the introduction of deferred income streams that will help to protect against longevity risk (¶16-570). Pooled lifetime income streams meet the declining capital access schedule (CAS) requirements set out in the SIS Regulations. This effectively limits the percentage of the initial purchase price that can be returned as either a surrender value (outside the 14-day free-look period) or death benefit. This limit is based on a straight-line declining value over the client’s life expectancy and reduces to zero by the time the client’s life expectancy (from commencement) has been reached. The impact is that once life expectancy is reached, while income payments continue to be paid, the client effectively relinquishes all rights to capital, which supports the group pooling concept. Purchased from 1 July 2019 Different assessment rules will apply to lifetime income streams that meet the CAS rules and those that do not. This is shown in the table below. Income stream category

Assessment

Pooled lifetime income stream that meets the CAS requirements

Asset test 60% of the purchase price is an assessable asset until the client reaches age 84* with a minimum of at least five years. After this time, the assessable value reduces to 30% Income test 60% of income paid is assessable income

Lifetime income stream that does not meet the CAS requirements (ie surrender/death value is greater than CAS limits)

Asset test

Assessable asset value is the greater of: – 60% of the purchase price to age 84* (minimum of at least five years), then reduces to 30% – any current or future surrender value that exceeds the CAS limits, or – any current or future death benefit that exceeds the CAS limits Income test 60% of income paid is assessable income * This figure is set in legislation and is based on the life expectancy of a 65-year-old male.

Example Emilio is age 65 when he purchases a lifetime income stream with $200,000 on 1 July 2020. Assume the initial income payment is $10,000 per annum (indexed). This income stream has no RCV and meets the requirements under the CAS. For Centrelink purposes, his assessable asset value is $120,000 until age 84, then it reduces to $60,000 for the rest of his life. His Centrelink assessable income is $6,000 in the first year. This changes with indexation but is always 60% of the income payments. Lucia is age 82 when she purchases a lifetime income stream with $200,000 on 1 July 2020. Assume the initial income payment is $36,000 (non-indexed) for life. This income stream has no RCV and meets the requirements under the CAS. For Centrelink purposes, her assessable asset value is $120,000 for the first five years (until she reaches age 87), then it reduces to $60,000 for the rest of her life. Her Centrelink assessable income is $21,600 each year.

As these rules are also relevant for deferred income streams, the date that assessment commences is important. The purchase price (or commencement date) for means testing is set out in the table below. For superannuation income streams

For non-superannuation income streams

Purchase date is the later of:

Purchase date is the earlier of:

– the day the first amount is paid for the income stream

– the day payments start, and

– the day the income stream is acquired (if purchase is not identifiable)

– the later of:

– the day that a specific condition of release is met (will match SIS conditions of release in s 1.06A(3)(a) of SIS Regulations)

– the day the first amount is paid for the income stream – the day the income stream is acquired (if purchase is not identifiable) – the day the person reaches Age Pension age

If a life product is attached to the income stream, the asset value of the life product is assessed separately as the greater of the surrender value and the purchase price paid (ie premium) if the life product is: • purchased after reaching Age Pension age, and • the sum of amounts paid in a 12-month period for the purchase exceeds 15% of benefits payable at death. If the pooled lifetime product is held inside an account-based income stream, the lifetime component is assessed separately under these rules. Purchased before 1 July 2019 Lifetime income streams purchased before 1 July 2019 are grandfathered under the old rules and are assessed under the Centrelink/Veterans’ Affairs (DVA) deductible rules (¶16-598). This has implications for both assets and income testing and, depending on circumstances, may provide a more favourable outcome than other investment options that are subject to deeming. If the lifetime income stream was purchased on or after 20 September 2007 but before 1 July 2019, the full purchase price started as an assessable asset. The asset value reduces each six months by the return of capital, as determined by the calculated deductible amount for income payments that have been paid over that six-month period. If income payments are only made annually, this reduction will occur once a year when that income payment is made. Under the income test, the income payments less any deductible amount are assessable as income.

¶16-596 Term allocated pension assessment In social security legislation, term allocated pensions (TAPs) are referred to as market-linked income streams.

Assets test assessment For social security purposes, TAPs receive a 50% asset test exemption if purchased before 20 September 2007. The assessable asset value is adjusted every six months based on changes in the account balance. Specific rules apply to regulate when and how the 50% exempt TAPs can be commuted and rolled over to start another TAP to keep the exemption and avoid raising a debt for social security purposes. If the rules are not met, the debt created effectively winds back the asset test exemption on the original pension for the previous five years. The new TAP will not retain the 50% exemption unless the original TAP is fully commuted and rolled over to commence a new TAP that meets all the requirements under s 9BA of the Social Security Act. Income test assessment Deductible rules apply to assess income from a term allocated pension. The deductible amount is calculated as the purchase price less any residual capital value, divided by the number of years in the term.

¶16-598 Social security deductible amount rules If the deductible amount rules apply, part of the income received each year is non-assessable income. This is based on life expectancy or fixed term at commencement and aims to determine the amount of capital deemed to be returned in each income payment. The deductible amount is also used to determine the reducing asset value for lifetime and term certain income streams that have a residual capital value (RCV) less than 100%. The formula is: Purchase price − RCV − commutations  Relevant number  The relevant number for a term certain income stream is the number of years in the selected term. Example Olive purchases a seven-year annuity for $300,000 with a 50% RCV. The social security deductible amount is calculated as ($300,000 − $150,000)/7 = $21,429 per annum.

The relevant number for a lifetime income stream is the purchaser’s life expectancy under the relevant life expectancy table (unless an automatic reversionary). For income streams commenced from 1 January 2020, the 2015/17 Life Tables published by the Australian Government Actuary are used. Example On 8 October 2018, Chandi buys a lifetime annuity for $150,000. Chandi was aged 65 with a life expectancy of 19.22 years, based on the 2010/12 Australian Life Tables that applied at the time of purchase. If Chandi did not nominate an automatic reversionary, his social security deductible amount is $150,000/19.22 = $7,804 each year.

Reversionary income streams If a lifetime income stream is assessed under deductible rules and was set up with an automatic reversionary beneficiary, the deductible amount is based on the longer life expectancy of the purchaser and the reversionary beneficiary. Example Chandi’s wife Leila was aged 63 with a life expectancy of 23.80 years, based on the 2010/12 Australian Life Tables. If Chandi nominates Leila as an automatic reversionary, she assumes ownership upon his death and continues to receive income

payments for the rest of her life. Therefore, the deductible amount is based on her longer life expectancy from commencement. Chandi’s deductible amount is $150,000/23.80 = $6,303 each year. The income stream is fully asset tested in both situations but the asset value reduces each six months in line with the applicable deductible amount (¶16-620).

Impact of commutations Commutations are not counted as assessable income for social security purposes, but will reduce the deductible amount going forward if deductible rules apply. The purchase price is reduced by the value of any commutations paid to recalculate the new deductible amount. The relevant number remains at the original term or life expectancy factor.

MAXIMISING RETIREMENT INCOME — STRATEGIES ¶16-600 Maximising income in fixed term and lifetime income streams With a fixed term (¶16-200) or lifetime income stream (¶16-300), the client reduces some of the normal investment risks and also some of the longevity risks. The provider takes the market risk instead of the client. The regular payments continue to be made regardless of what happens in the financial markets. However, shedding of market risk is reflected in the pricing of the income stream. If interest rates are low when the income stream is purchased, the client will be locking into low rates. These income streams provide a better outcome if purchased when interest rates are high (if possible). The income level is specified in the contract and depends on: • the amount of funds used to purchase the income stream • the term or, with lifetime income streams, the age of the annuitant and reversionary (if applicable) • frequency of payments • interest rates prevailing at the time of purchase • levels of indexation for income • the RCV chosen (if available) • pricing policy of the provider • options included in the contract. As with any investment product, it is worth shopping around for quotes before recommending fixed term or lifetime income streams as returns can vary significantly between providers. To determine if these products are suitable for a client, and which options to include, the following issues are important to consider: • life expectancy and health to determine the value of options • income needs now and in the future and the effects of inflation • need for access to capital • social security implications. It may also be useful to obtain quotes with and without certain features to determine what is most important to a client and what they are willing to trade-off. For example, quotes with indexation of income

are likely to produce lower initial income levels. Quotes with full CPI indexation may also produce a different starting income than quotes with a fixed rate of indexation.

¶16-610 Transition to retirement and salary sacrifice strategy The introduction of transition to retirement income streams (¶16-585) saw the development of a popular strategy for a person working full-time that used a combination of salary sacrifice and a transition to retirement pension. This provided taxation advantages to increase the value of superannuation benefits, especially for a person over age 60. However, the taxation rules changed from 1 July 2017 and this reduced the strategy’s popularity. A transition to retirement pension is no longer considered to be a retirement phase income stream so the earnings are not tax-free (even if purchased before 1 July 2017). The earnings are now taxed at 15% in the fund under the same rules that applies to the accumulation phase. This has significantly reduced the advantages of a transition to retirement pension. While some tax concessions can still apply (mostly for a client age 60 or over), rather than being a tax minimisation strategy a transition to retirement income stream may now be more effective for clients who want to increase disposable income (using preserved superannuation) for purposes such as debt repayment or to meet living expenses.

Advice tips There are three main limitations on this strategy which need to be checked before making any recommendations to clients: • concessional contributions (includes total of superannuation guarantee, salary sacrifice and personal deductible contributions) are capped per financial year. A cap of $25,000 in 2020/21 may limit the ability to use this strategy • the income payments from a transition to retirement pension in the year of commencement must be between 4% and 10% of the account balance at commencement (not pro-rated) and in each subsequent year must be between 4% and 10% of the balance on 1 July (for 2020/21 the minimum payment is halved to 2%) • earnings in a transition to retirement pension are taxed the same as earnings in the accumulation phase and the pension does not count against the transfer balance cap until the client reaches age 65 or notifies the trustee that a full condition of release has been met. Other issues to consider are: • check whether other employment benefits (such as superannuation guarantee, workers’ compensation, income protection, long service leave, etc) are calculated on the total employment cost or the cash salary component only. If paid on the reduced cash salary this may negate any benefits of the strategy • the salary sacrifice arrangement needs to be a genuine arrangement and must only apply to income not already earned • clients can choose to use this strategy with personal deductible contributions instead of salary sacrifice arrangements, but these contributions are still assessed against the concessional contribution cap • the Australian Taxation Office (ATO) issued a press release stating that a simple salary sacrifice and transition to retirement pension strategy will not breach Pt IVA general anti-avoidance rules, but care should still be taken as a press release does not have legislative power • the fees and costs involved in setting up the strategy.

Example 1 Chris is aged 57 and on a salary of $150,000 in 2020/21. He has $500,000 (all taxable component) in his superannuation fund. Chris is considering whether to use a transition to retirement strategy. His employer has agreed to pay 9.5% superannuation guarantee on his full $150,000 employment cost regardless of how much is taken as cash salary. His ability to salary sacrifice without creating an excess concessional contribution (ie $25,000 cap) is limited to $10,750.

Without salary sacrifice or transition to retirement strategy

With salary sacrifice or transition to retirement strategy

$150,000

$139,250

Nil

$20,000^^

$45,997

$49,605

Nil

$3,000

$104,003

$112,645

Nil

$8,642

Disposable income

$104,003

$104,003

Superannuation balance

$500,000

$500,000

Plus: investment earnings**

$35,000

$35,000

Plus: contributions (concessional)

$14,250

$25,000*

Nil

$8,642

$7,388

$9,000^

Nil

$20,000

$541,862

$539,642

Cash salary Plus: Pension income Less: PAYG tax (incl 2% Medicare) Plus: pension offset Net income Less: non-concessional contribution

Plus: contributions (non-concessional) Less: tax in fund (on investment earnings and concessional contributions) Less: pension payments Net super balance end year

* The maximum concessional contributions cap (over age 50) is $25,000 for 2020/21. ** Assumes 7% net earnings. Also assumes all contributions are made at the end of the year. ^ 15% tax is paid on earnings in the pension phase (transition to retirement). The new contributions will add to accumulation phase and tax will be paid on those earnings in subsequent years unless the pension is reset with full balances.

^^ Uses the standard minimum pension required to be withdrawn (4%). This increases Chris’ net income so the additional $8,642 is recontributed to superannuation as a non-concessional contribution. However, note for 2020/21 the minimum is halved to 2% and this will reduce the amount that needs to be taken and then recontributed to super.

This strategy has left Chris with the same net disposable income but his super balance has decreased by $2,220 due to higher tax on personal income. This strategy may become beneficial if part of the pension income is tax-free component or he was over age 60. It also assumes that the same fees are payable in accumulation and pension phases.

Example 2 The strategy may be more effective for a person aged 60 or older because the pension income is not included in taxable income. The table below shows the results if Chris was aged 60 or over.

Cash salary Plus: Pension income Less: PAYG tax (incl Medicare)

Without salary sacrifice or transition to retirement strategy

With salary sacrifice and transition to retirement strategy

$150,000

$139,250

Nil

$20,000^^

$45,997

$41,805

Less: pension offset

Nil

Nil

$104,003

$117,445

Nil

$13,442

Disposable income

$104,003

$104,003

Superannuation balance

$500,000

$500,000

Plus: investment earnings**

$35,000

$35,000

Plus: contributions (concessional)

$14,250

$25,000*

Plus: contributions (non-concessional)

Nil

$13,442

Less: tax in super fund (on investment earnings and concessional contributions)

$7,388

$9,000^

Nil

$20,000

$541,862

$544,442

Net income Less: non-concessional contribution

Less: pension payments Net super balance end year * The maximum concessional contributions cap is $25,000 in 2020/21.

** Assumes 7% net earnings. Also assumes all contributions are made at the end of the year. ^ 15% tax is paid on earnings in the pension phase (transition to retirement). The new contributions will add to accumulation phase and tax will be paid on those earnings in subsequent years unless the pension is reset with full balances.

^^ Uses the standard minimum pension required to be withdrawn (4%). This increases Chris’ net income so the additional $13,442 is recontributed to superannuation as a non-concessional contribution. However, note for 2020/21 the minimum is halved to 2% and this will reduce the amount that needs to be taken and then recontributed to super.

This strategy has left Chris (who is over age 60) with the same net disposable income but his super balance has increased by $2,880.

¶16-620 Strategies to maximise social security with income streams Strategies using some income streams may be available to improve a client’s social security or veterans’ affairs benefits. Over time many of the strategies have diminished due to means-testing changes. But the changes to pooled lifetime income streams from 1 July 2019 have potentially increased the asset test advantages (see ¶16-593). Strategic considerations may also be important for retaining existing income streams or where nonaccount based pensions are appropriate. The same rules apply to means-testing for aged care. Strategies that reduce assessable assets and/or income may reduce aged care fees for home care and/or residential care (see ¶16-630). Retaining fully or partially exempt income streams Complying lifetime and term certain income streams purchased before 20 September 2007 (¶16-830) may be either 100% or 50% asset test exempt. Retaining these income streams can reduce assessable assets and increase Centrelink/DVA entitlements. Particular care needs to be taken if any restructuring is done or income streams are commuted (even if rolled over to a new income stream) to ensure grandfathering of the exemptions is maintained and a debt for past concessions is not raised by Centrelink (see ¶16-840). All non-purchased defined benefit pensions continue to be assets test exempt provided they are noncommutable. Reducing assessable assets Term income streams with an RCV less than 100% will have a diminishing asset value each six months which represents the return of capital over that six-month period (ie half the annual deductible amount).

However, if income payments are only made annually, the reduction will only occur at the end of each year. This reducing asset value may help to maintain an ongoing income stream but with a reducing asset value for both Centrelink/Veterans’ Affairs and aged care fees. Example Alice, age 65 purchased a term certain annuity for $200,000 for a term of 23 years (to approximate life expectancy). This has a starting asset value of $200,000 and an annual deductible amount of $8,696 ($200,000/23). Each six months the Centrelink assessable asset value reduces by $4,348. If she is spending this money as it is received, her assessable assets will be reducing (subject to other investment changes).

From 1 July 2019, new pooled lifetime income streams that meet the CAS requirements (¶16-593) will have the assessable asset value reduced by 40%, ie the assessable asset value is 60% of the purchase price. This assessment applies until the earlier of reaching age 84 or the end of the first five years, at which point the assessable value drops to 30% of the initial purchase price. These income streams may reduce assessable assets and increase Centrelink/DVA entitlements (or reduce aged care fees) but caution is needed as clients are locking into income streams with limitations on any surrender or death value. Example India, age 65, purchased a lifetime annuity on 1 July 2020 for $200,000. The assessable asset value is $120,000. She has reduced her assessable assets by $80,000 to $120,000 (ie 60% of purchase price). When she reaches age 84 (which is more than five years away), the assessable asset value reduces a further $60,000 to $60,000 (ie 30% of purchase price).

Note If a client’s pension is reduced because of assessable assets, reducing assessable assets by $100 could increase age pension by $7.80 per year. This is effectively a 7.8% return in addition to the investment return on the income stream. This assumes that the income test is not the dominant test.

Reducing assessable income (deductible rules) Under the Centrelink/Veterans’ Affairs income test, deductible amount rules apply to the following income streams: • fixed term income streams with a term greater than five years • fixed term income streams with a term that is five years or less but longer than the client’s life expectancy • term allocated pensions • lifetime income streams purchased before 1 July 2019, and • account-based pensions (including those started under transition to retirement rules) provided the pension was commenced before 1 January 2015 and the owner has continually received a Centrelink or Veterans’ Affairs means-tested payment or the blind pension since 31 December 2014. Under deductible rules, assessable income is calculated as income payments received in a year less the amount determined to be a return of capital (ie the deductible amount). This may produce a lower assessment than would apply under deeming on the same amount of money, but when deeming rates are low, deductible rules do not always produce a better result. Deductible amount = (Purchase Price less Residual Capital Value less commutations)  Relevant life expectancy or term (at commencement) 

Life Expectancy Tables are included at ¶20-250. The 2015/17 Life Tables apply for lifetime income streams commencing from 1 January 2020. The 2010/12 Life Tables apply for lifetime income streams commencing from 1 January 2015 to 31 December 2019. It is important to note that the deductible amount for defined benefit pensions (except those paid from Military super schemes) is restricted to a maximum of 10% of the year’s payments from 1 January 2016. Example Alice (from example above) selected no indexation on her income payments. Assume the income is $12,000 per year. This is more than her deductible amount of $8,696, so $3,304 is classified as assessable income by Centrelink. If instead, Alice invested $200,000 into an account-based pension or other deemed investment, the income assessment as at 1 July 2020 is $3,440. The annuity has reduced her assessable income by only $136 per annum due to the low deeming rates, but may see a slight increase in pension entitlements under the income test. But comparison of overall investment returns is also important to compare.

Including indexation on a term certain annuity may help to protect against inflation (by reducing income now in exchange for higher income later) but may also improve Centrelink/Veterans’ Affairs advantages in the earlier years due to the lower levels of initial income. It is important to consider the client’s full circumstances to match their objectives and maximise their total financial well-being not just the impact on Centrelink/Veterans’ Affairs or aged care fees. The impact of both tests also needs to be considered. Reducing assessable income — pooled lifetime income streams from 1 July 2019 The income assessment of pooled lifetime income streams purchased from 1 July 2019 is 60% of the income payments received. Depending on the income payments received and deeming rates, this may or may not provide an advantage under the income test compared to deemed investments. Example India (from example above) selected indexation on her income payments. Assume the income starts at $10,000 for the first year. Her assessable income is 60% of each year’s payment, so it starts at $6,000 in the first year. If instead, India invested $200,000 into an account-based pension or other deemed investment, the income assessment as at 1 July 2020 is $3,440. The lifetime annuity did not provide an advantage under the income test as it increased her assessable income by $2,560 pa. The outcomes are dependent on deeming rates and income pricing on the annuity. Comparison of overall investment returns is also important to compare.

Retaining grandfathering of account-based pensions It is important that before fully commuting or rolling-over account-based pensions which are assessed under the grandfathered deductible amount rules, the implications of switching to deeming should be assessed and compared. This may also need to take into account how deeming rates may change in the future. Using income streams that are assessed under the deductible amount rules instead of deemed investments may reduce assessable income and increase social security payments. But not in all cases as it depends on individual circumstances and the deeming interest rates. Example Matt, aged 65, and Matilda, aged 65, both purchased an account-based pension for $330,000 on 1 July 2014. They are both single, have assessable assets below the lower asset test threshold and receive no other income. They both earned 7% ($23,100) on their investment in the first year. At the time of purchase, Matilda’s life expectancy was 21.62 years while Matt’s was 18.54 years (used 2005–07 tables applicable at date of purchase). Matt decided he was unhappy with his account-based pension provider and rolled his money over to start a new account-based pension on 1 July 2020. He loses the grandfathering status and his new account-based pension will be assessed under deeming rules (see ¶16-600 for details on deeming). Note that this uses deeming rates and thresholds current at 1 July 2020: [($330,000 − $53,000) × 2.25%] + ($53,000 × 0.25%) = $6,365

Under the income test (and ignoring assets test), Matt is entitled to receive a part Age Pension (current to 19 September 2020) of $910.90 pf ($23,683 pa). Matilda continues with her original account-based pension and stays under deductible amount rules. If she chooses to draw the standard minimum pension of $11,500 ($330,000 × 5%) from her account-based pension, her social security assessable income is calculated as (see ¶6-640): $16,500 − ($330,000/21.62) = $1,236 pa Under the income test (and ignoring the assets test), Matilda is entitled to receive the full Age Pension (current to 19 September 2020) of $944.30 pf ($24,552 pa). By retaining her account-based pension, Matilda receives an extra $869 pa Age Pension. Matilda has not used much of her income test threshold so she is still able to earn another $3,392 pa of assessable income before her pension is reduced. For 2020/21, Matilda is able to draw half the standard minimum. This would reduce her assessable income to nil. If the deeming rates increase, the relative benefit to Matilda will increase as higher deeming rates will reduce Matt’s pension entitlement. Matilda’s result will depend on how much income she draws each year. Note that the deeming and lower income test thresholds apply for the 2020/21 financial year. Age Pension and deeming rates are current until 19 September 2020.

The impact of such a strategy on the client’s asset test position should also be considered as that may be the dominant test, making the relative difference in assessable income irrelevant. Always keep in mind that the income stream selected must meet the client’s overall financial objectives and not just aim to maximise age pension. Deciding on additional income or commutation Centrelink will assume all payments received from an income stream are income, unless they are otherwise notified. Therefore, clients assessed under the deductible amount rules (¶16-598) who withdraw lump sums should decide whether to advise Centrelink that the withdrawal is in the nature of a partial commutation instead of additional income. This may reduce the impact under the income test for the current year, but will have an ongoing reduction to deductible amount in future years. Example Gladys was aged 63 (life expectancy 23.35) when she started an account-based pension with $200,000 on 1 July 2013. She has remained in receipt of income support payments since that time, so the account-based pension is grandfathered under deductible amount rules. Her deductible amount for social security purposes (ie non-assessable income) was calculated as $200,000/23.35 = $8,565. If she chooses to withdraw the standard minimum income of $8,000 (noting that in 2020/21 the minimum is $4,000), no assessable income is calculated. In October 2020 Gladys withdraws a lump sum of $10,000. Unless she advises Centrelink that it is a commutation, they may deem it to be an income payment. This recalculates her assessable income to $18,000 − $8,565 = $9,435. However, if she advises Centrelink that it is a commutation, the $10,000 withdrawn does not count in the income test but it will reduce the ongoing nonassessable income portion to ($200,000 − $10,000)/23.35 = $8,140. This may increase assessable income in each future year by $425.

¶16-630 Strategies to minimise aged care fees Clients who access government subsidised home care packages are subject to income testing. The fees for residential aged care are subject to means testing using a combined assessment of income and assets. The rules used to assess assessable income and assets for both home and residential care are the same as the rules that apply for Centrelink/Veterans’ Affairs (DVA) means testing (¶16-590–¶16-598). Therefore, the strategies that minimise assessable income or assessable assets may help to reduce aged care fees, depending on the client’s circumstances. These strategies involving income streams may include: • maintaining complying income streams to retain the asset test exemption • reviewing client situations when circumstances change to avoid where possible losing Centrelink/DVA payments for even one week, and thereby triggering a shift to deeming rules under the income test for account-based pensions grandfathered under the deductible rules, if the deductible rules are

more advantageous (¶16-598) • using lifetime or term certain income streams to access deductible rules under the income test (instead of deeming) if this reduces assessable income and to potentially reduce the amount of assessable assets • using lifetime income streams that meet the capital access schedule rules to gain reductions in assessable income and assets. It is important to consider strategies carefully, as clients accessing aged care services (particularly residential care) may have short life expectancy periods. Aged care rules are dealt with in more detail in Chapter 17.

¶16-640 Changing income stream providers Clients may decide to change income stream providers for many reasons such as: • they are not satisfied with the service provided • they are dissatisfied with the investment returns • they believe the fees are excessive • they wish to take advantage of legislative changes or product developments • their risk profile/investment objectives have changed. Changing account-based pension providers It is usually easy to switch providers of account-based pensions. However, be aware that if the client is a Centrelink/Veterans’ Affairs (DVA) recipient they will lose the grandfathering of deductible amount rules if they switch providers. Account-based pensions commenced before 1 January 2015 are assessed under deductible rules provided the person has continuously received a means-tested payment or the blind pension from Centrelink/DVA since 31 December 2014. But if a pension commenced before 1 January 2015 is commuted and a new pension commenced, the new pension will be assessed under deeming rules. Deeming rules may be less (or more) beneficial than deductible rules depending on the client’s circumstances and deeming rates. Changing term allocated pension providers Term allocated pensions will not be offered to new investors from 20 September 2007. However, providers may allow someone who commutes an existing term allocated pension to commence a new term allocated pension. The number of providers who offer a switch is limited. For Centrelink/DVA purposes, if the income stream is switched to a term allocated pension with a new provider, it will not retain its asset test exemption (the new income stream will be fully asset tested going forward) unless it meets one of the limited situations such as: • commutation and rollover is due to a successor fund transfer • the pension is paid from an SMSF and the fund is being closed due to death of a member or because the administration is becoming too onerous • the pension was originally set up as reversionary but the reversionary spouse has since died • the pension is being split to pay a divorce property settlement, financial hardship amount or surcharge debt. In all cases, the term allocated pension must be fully commuted and fully rolled to a new term allocated

pension.

Note Refer to section ¶16-840 for details on the social security treatment of commutations from complying asset test exempt income streams.

Fees and costs may also apply. The split between tax-free and taxable components will remain the same if the original income stream commenced on or after 1 July 2007 or if it started before that date and had previously satisfied a trigger event. Switching investment options Switching investment options in a retail fund, master trust or wrap platform is not deemed to be a commutation. Therefore, no changes to taxation or social security apply. Issues for consideration Before transferring to a new income stream, advisers should consider: • any exit and entry costs that might apply to the new income stream. • changing providers creates an opportunity to review estate planning implications. For example, is a reversionary option required? • a pro-rata minimum income payment may need to be paid for an account-based income stream (¶16510). • if the assessable income from the income stream was assessed by Centrelink/DVA under the grandfathered deductible amount rules, the impact of moving to deeming on a new income stream.

TAXATION OF INCOME STREAMS ¶16-700 Introduction to taxation of income streams Superannuation income streams are tax-effective vehicles for generating an income stream. The tax benefits depend on the client’s age at the time that a payment is received: • from age 60 — income payments are tax-free and are not included in assessable income (unless the income stream is paid from an untaxed scheme such as some public sector superannuation schemes) • preservation age to age 60 — lump sum tax which is otherwise payable on a superannuation lump sum is deferred if the money is rolled over from accumulation to an income stream. The taxable component of income payments is included in taxable income and taxed at the client’s marginal tax rate less a 15% tax offset • under preservation age — lump sum tax which is otherwise payable on a superannuation lump sum is deferred if the money is rolled over from accumulation to an income stream. The taxable portion of income payments is included in taxable income and taxed at the client’s marginal tax rate. A 15% tax offset only applies if the pension is paid as a result of death or permanent incapacity. In addition, regardless of the client’s age, earnings are currently added to the client’s retirement income stream account tax-free, as calculated under exempt current pension income rules (see below), and unused franking credits can be claimed as a cash refund back into the fund. From 1 July 2017, transition to retirement income streams (¶16-610) are not considered to be retirement income streams and as such,

the trustee will pay 15% tax on earnings within the fund (under the same rules that apply to the accumulation phase). From 1 July 2017, it is also important to consider the impact of the transfer balance cap (¶16-155) when starting a new retirement income stream. Under the rules for this cap, each individual can only roll up to their personal transfer balance cap into retirement income streams. The general cap was initially set at $1.6m and continues to apply at this rate in 2020/21. This cap includes the 30 June 2017 value of existing income streams and death benefit income streams received. Calculating exempt current pension income Earnings generated by the assets used to support current retirement pension obligations are added to the fund tax-free — defined as exempt current pension income (ECPI). The calculation of ECPI can be complicated in many cases, especially where accumulation and pension balances have existed in the fund in that year. Therefore, legislation applies rules for the calculation of ECPI under either proportionate or segregated rules. This is particularly relevant for SMSFs.

Note Segregation rules for tax exemptions do not apply to income streams paid under the transition to retirement rules (¶16-585) as earnings are taxable on these income streams from 1 July 2017. Transition to retirement pensions are not classified as retirement phase income streams.

The rules for calculating ECPI changed from 1 July 2017 with the introduction of section 295.387 into the Income Tax Assessment Act 1997. Under these changes, the segregated method is to be used for periods during the year when all assets of the fund were in the retirement pension phase and the proportionate method must be used for the rest of the time. This caused complexity with the potential for using different methods for different periods of the same year. However, it should also be noted that an SMSF is unable to use the segregated assets method to claim ECPI if all of the following apply: • at any time during the financial year there is a least one retirement income phase interest within the fund, and • just before the start of that financial year the member had a total superannuation balance over the general transfer balance cap threshold ($1.6m for 2017/18 to 2020/21) and they commenced a retirement phase income stream within the SMSF or another fund, and • at any time during the financial year that member holds a superannuation interest (accumulation or retirement phase) within the SMSF. If the segregated method is not allowed, the trustee will need to use the proportionate method to calculate the ECPI. An actuarial certificate will be required to calculate the proportion of tax exempt income.

Tip It is important that clients who have account-based pensions take the minimum income payment required each financial year. If not, the Tax Office will consider that the account has been in accumulation phase for the whole year and the 15% superannuation earnings tax will apply to all earnings generated throughout that financial year.

Example Harry started an account-based pension from his SMSF on 1 July 2020 with $600,000. He was age 67 so his minimum income payment is $15,000 ($600,000 × 2.5%). The minimums are halved for the 2020/21 financial year compared to the normal standard minimums. However, during the 2020/21 financial year his account generates $55,000 of earnings (no capital gains) and Harry only withdraws payments of $10,000. As such he does not meet his minimum income requirement. The Tax Office will consider his account has been an accumulation account for the whole financial year. The SMSF trustee will need to declare the $55,000 of fund earnings as assessable income and tax of $8,250 applies.

Proposed changes from 1 July 2021 In the 2019 Federal Budget, the government announced proposed changes to wind back the 1 July 2017 rules for ECPI. These changes were proposed to commence from 1 July but the proposed start date has been moved back to 1 July 2021. If the legislation is passed, a fund with both accumulation and retirement interests will be able to: • use the current rules (ie using segregation rules (if eligible) only when all benefits are in retirement pension phase, and the proportionate method at all other times), or • use the proportionate method all year. In addition, it is also proposed that an actuarial certificate is not needed under the proportionate method if all funds are fully invested in the retirement pension phase for the whole year. Legislation is still required to be introduced and passed, so changes may occur. Considerations for the financial adviser The tax-free status of withdrawals from income streams by clients age 60 and over may make superannuation income streams tax effective compared to other investment options. This has often made income streams a central component of a client’s retirement plans. Account-based pensions are likely to be the main income stream used by many clients, but some clients may benefit from a mix of income streams to more effectively manage the trade-offs and to suit various components of income needs. The challenge is to remain aware of product developments and pick the right mix of products to generate a secure income to meet basic daily needs and maintain flexibility for other irregular and unexpected expenses. It is vital that an adviser fully understands the interlocking taxation, superannuation, investment, social security, aged care, psychological and personal issues, which must be resolved before an appropriate income stream can be recommended. The tax-free nature is the topic of ongoing political discussion with a focus on whether the concessions are fair and sustainable. Taxation of income streams could change in the future so clients should always be made aware of the potential for less tax-effective outcomes. For example, the 2017 changes that reduced contribution caps, applied tax to the earnings in a transition to retirement income stream and introduced the transfer balance cap, indicated the government’s first steps towards limiting the taxation concessions of income streams. Following these changes, clients who are members of a couple may wish to consider accumulating superannuation in the names of both partners to maximise the amount that can be rolled over to income streams. For clients who accumulate savings greater than the transfer balance cap, they will need to consider leaving the excess in the accumulation phase of superannuation or withdrawing to invest outside the superannuation environment once a condition of release can be met.

¶16-710 Tax on income streams (commenced from 1 July 2007)

Splitting the components Upon commencement of a superannuation income stream, the lump sum used to purchase the income stream is split into tax-free component and taxable component. Refer to ¶1-285 for details on what is included in each component. The split is determined as the percentage that each component forms of the client’s total amount used to purchase the income stream. If commenced from an SMSF, the total of the member’s accumulation accounts (but not existing pension accounts) are amalgamated to determine the proportionate split. These rules apply to both transition to retirement income streams and retirement phase income streams. Example Caroline is a member of an SMSF. She has two accumulation accounts in her SMSF totalling $660,000. The individual accounts have the following splits: Account A — taxable $300,000 and tax-free $50,000 Account B — taxable $80,000 and tax-free $230,000 Caroline rolls over the balance of Account B to start an account-based pension with $310,000. The split between tax-free and taxable components is calculated as: Tax-free = ($280,000/$660,000) × $310,000 = $131,515 Taxable = $310,000 − $131,515 = $178,485 The components of Account A are then readjusted to: Tax-free = $148,485 Taxable = $201,515

This percentage (42.42%) remains fixed for the life of the income stream. Each pension payment or lump sum withdrawal (including death benefit) is split using the same percentage. This means that earnings added to an income stream account are split between tax-free and taxable components. For a person aged 60 or older this does not have much relevance as all income payments and lump sums are tax-free (from a taxed source); however, it has an impact on the taxation of any death benefits paid to a non-death benefits dependant as the death benefit is split between components using this same percentage. Example Melissa was aged 57 when she rolled $500,000 into an account-based pension on 20 August 2014. Her lump sum included a taxfree component of $100,000. This represented 20% of her total balance. Melissa took an income payment of $20,000 per annum. Each payment was split as 20% tax-free income and 80% taxable income. Her taxable income was added to assessable income and taxed at her marginal rate but as she was over age 55, she was eligible for a 15% tax offset on this amount (¶16-770). All income payments received after her 60th birthday will be paid tax-free. Melissa dies six years later in September 2019 with a remaining balance of $480,000. Her death benefit is paid to her adult daughter and comprises $96,000 (20%) tax-free component and $384,000 (80%) taxable component. Her daughter is not a death benefits dependant so she will pay tax at the rate of 15% (plus Medicare levy) on the taxable component. Tax payable is $65,280 (including Medicare of 2%).

Taxation from age 60 Regardless of the component split, any payments received after turning age 60 from a taxed superannuation scheme, either as income or a lump sum, are tax-free. These amounts are also neither assessable income nor exempt income. This means they do not need to be included in the client’s tax return. If the income stream is paid from an untaxed scheme (such as some public service super schemes), the income payments are still taxable income but a 10% tax offset will apply to the taxable income. For taxation of lump sum withdrawals, refer to ¶1-285.

If the income stream is commuted upon death and paid to a non-death benefits dependant, it is split into taxable and tax-free components and taxed at lump sum tax rates. Taxation under age 60 The taxable portion of income payments received under age 60 is taxable in the client’s hands at their marginal tax rate. This includes Medicare levy and any other levies that apply to taxable income. There is no tax on the tax-free portion. The taxable income is calculated as: taxable income = income payment − tax-free portion Tax is deducted by the income stream provider under the PAYG tax collection system (¶16-730). If the client is over their preservation age or the income stream is paid due to permanent incapacity or the death of another person, a 15% tax offset will apply to reduce the tax payable. The taxable income from an untaxed scheme is fully taxable at the client’s marginal tax rates. This includes Medicare levy and any other levies that apply to taxable income.

¶16-720 Tax on income streams commenced before 1 July 2007 Splitting the components An income stream commenced before 1 July 2007 did not immediately switch to the new splitting rules (¶16-710). It continues to use the taxation rules which applied at commencement of the income stream to determine the tax-free income portion until one of the following trigger events occurs: • the person reaches age 60 • a full or partial commutation is made • the person dies. If the person was already age 60 on 1 July 2007, that date was the trigger event and the new rules applied from that date. By now, most people are likely to have met one of these trigger conditions. Once a trigger event occurs, the split between tax-free component and taxable component is calculated at the trigger date using the component splitting rules (¶16-710). This split applies for the duration of the income stream. Taxation from age 60 Regardless of the component split, any payments received by the client (from a taxed scheme) after turning age 60, either as income or a lump sum, are tax-free. These amounts are not assessable income or exempt income. This means they do not need to be included in the client’s tax return as assessable income. If the income stream is paid from an untaxed scheme (such as some public sector schemes), the income payments are taxable income but a 10% tax offset will apply. For taxation of lump sum withdrawals refer to ¶1-285. Taxation under age 60 If a trigger event has still not occurred, income payments received under age 60 are taxable in the client’s hands at their marginal tax rate (includes Medicare levy and any other levies that apply to taxable income), but may include a tax-free component called the deductible amount. The taxable income is calculated as: taxable income = income payment − deductible amount Tax is deducted by the income stream provider under the PAYG tax collection system (¶16-730). If the client is over their preservation age or the income stream is paid due to permanent incapacity or the

death of another person, a 15% tax offset will apply to reduce the tax payable. The taxable income from an untaxed scheme is fully taxable at the client’s marginal tax rates. This includes Medicare levy and any other levies that apply to taxable income. Calculation of the deductible amount The deductible amount is calculated using the rules that existed at the time the income stream commenced and applies until a trigger event occurs to switch the income stream to the splitting rules. The deductible amount represents the deemed return of capital in each income payment, apportioned equally over the term for which the income stream will be paid (or was reasonably expected to be paid). The deductible amount for taxation purposes was calculated by dividing certain components used to purchase the income stream by a relevant number, using the following formula: deductible amount = relevant share × (UPP − RCV)    relevant number where: • UPP is the undeducted purchase price • RCV is the residual capital value • relevant share for a single name annuity or pension is 1 or, if ordinary money income stream in joint names, is 0.5 • relevant number is the term or if no set term, the client’s life expectancy. If a reversionary option is chosen, the longest life expectancy is used. If the income stream is purchased with ordinary money, the undeducted purchase price is the entire purchase price. If purchased with superannuation money, the undeducted purchase price depends on when the pension or annuity was first payable. (1) First payable before 1 July 1983 — the UPP includes only the personal contributions for which the person could not claim a tax deduction or offset. (2) First payable on or after 1 July 1983 but before 1 July 1994 — the UPP is the sum of: • pre-1 July 1983 component • concessional component, and • undeducted contributions. (3) First payable on or after 1 July 1994 but before 1 July 2007 — the UPP is the sum of: • undeducted contributions (including spouse contributions and government co-contributions) • CGT-exempt component, and • post-30 June 1994 invalidity component (for pensions or annuities which commence to be payable after 4 June 1998). If the income stream was started with money rolled over from another income stream that commenced before 1 July 1994, those rules were used rather than the above rule. (4) Paid from a defined benefit scheme — the UPP includes only personal contributions made to superannuation for which a tax deduction or rebate could not be claimed. Excess deductible amount The deductible amount could only be used to reduce taxable income from income streams. If the taxable income payments in any financial year were less than the deductible amount, the excess amount could

offset other taxable income but could be carried forward to offset taxable income from income streams in future years. This usually only occurred in the initial years. Example Bart commenced an account-based pension before 1 July 2007, with a deductible amount calculated as $13,000. He elects to receive income of $12,000 in that first year. This is less than the deductible amount so his taxable income is reduced to nil. Bart has other taxable income, but the excess amount cannot offset that taxable income. The excess $1,000 deductible amount is carried forward to the next year. In the next financial year, he selects income of $14,000. His deductible amount is $13,000 plus the $1,000 carried forward, so his income is again all tax-free. When Bart turned age 60, none of his pension income is taxable any more so any carried forward excess deductible amount no longer has any value. When he reached age 60, the recalculation of the tax-free and taxable split will be triggered if it has not already been triggered.

¶16-730 Tax collected under the PAYG system for taxation If the client is under age 60 or it is an untaxed scheme, tax may be payable on income payments. The income stream provider will deduct income tax and Medicare levy (plus other levies that apply to taxable income) where applicable from each income payment under the PAYG system. Details are reported to the ATO for inclusion in personal tax returns. Clients under age 60 must complete a tax file number (TFN) declaration form so that the correct amount of tax can be deducted. If applicable, they can claim the general exemption (ie the tax-free amount available to all taxpayers) and other offsets (eg Senior Australian and Pensioner offset) to reduce the tax deducted. Most offsets can only be claimed on one income source, whether that is an income stream or salary. If a person has several income sources, they must choose the one for which to claim the general exemption and other concessional offsets. Tax instalments will be deducted at higher rates from the other sources. In many cases, this results in excess tax being deducted with a refund to the client at the end of the year after a tax return is submitted. Alternatively, the client could submit a PAYG variation form to the ATO to reduce the tax deducted. If approved, the ATO will issue a variation certificate, which should be forwarded to the income stream provider so that tax instalments can be reduced. Careful assessment of the client’s situation should be undertaken before submitting an application, as a shortfall in tax instalments can lead to significant taxation penalties. If a tax file number is not advised, tax is deducted at the highest marginal tax rate (ie 45% for 2020/21) plus the 2% Medicare levy.

¶16-740 The deductible amount and “relevant number” for taxation The tax-free portion of income for an income stream that commenced before 1 July 2007 but has not yet reached a trigger point (¶16-720) is known as the deductible amount. This was calculated as a portion of the money used to purchase the income stream (¶16-720) divided by the relevant number. For a fixed term or a term account-based pension, the relevant number was the actual number of years in the term. For an account-based or lifetime income stream, the Life Expectancy Tables most recently published before the start of the calendar year in which the income stream commenced were used. Life Expectancy Tables are included at ¶20-250. The current Life Tables (2015/17) where applicable, apply for income streams commencing on or after 1 January 2020. If a lifetime income stream has joint owners (ordinary money only) or a lifetime or account-based income stream has an automatic reversionary, the longest life expectancy was used. If a nominated beneficiary (discretionary reversion) was chosen, the original owner’s life expectancy was used. From a tax point of view, once a trigger point is met or if the income stream commenced from 1 July 2007, the life tables become irrelevant and tax-free income is based on age (ie over age 60 or not) and the split of underlying components.

Example Gunther purchased an account-based pension on 1 September 2006 with $150,000 after-tax contributions. Gunther was aged 55 and had a life expectancy of 25.92. His wife Jodie was aged 53 and had a life expectancy of 31.73. If Jodie was nominated as an automatic reversionary, the deductible (tax-free) amount was based on her longer life expectancy and applied to the pension paid to Gunther.

Deductible amount = $150,000   31.73 = $4,727 However, if Jodie was a nominated beneficiary (or discretionary reversionary), the deductible amount was calculated based on Gunther’s life expectancy.

Deductible amount = $150,000   25.92 = $5,787 Gunther died at age 59 and the pension reverted to Jodie. This was a trigger event so the components were recalculated to determine the split between tax-free and taxable components at that point in time. This split will determine how much of Jodie’s income is tax-free going forward (¶16-720). If Gunther had not died, he would have also met a trigger condition (ie reaching age 60) to have the income stream assessed under the fixed split method.

¶16-750 Maximising the tax-free component The tax-free component of an income stream may be increased by using a cash-out and recontribution strategy. This may help to minimise tax in the following situations: • income streams commenced before age 60 • death benefits paid to non-death benefits dependants (eg adult children). This strategy involves withdrawing a superannuation lump sum from the client’s superannuation account and then recontributing it back to superannuation as a personal non-concessional contribution (or spouse contribution to a spouse’s superannuation) before purchasing an income stream. Before recommending this strategy, ensure the client is eligible to contribute to superannuation (¶4-205) and consider the contribution caps (¶4-210 to ¶4-250) as well as any preservation restrictions (¶4-400). It may also be prudent to limit the amount that can be withdrawn to the amount that can be withdrawn taxfree (and also can be contributed back). The reduction in non-concessional contribution caps from 1 July 2017 has reduced the ability to use this strategy. As with any strategy, care should also be taken to ensure Pt IVA anti-avoidance provisions are not breached. Example Tony retires on 10 September 2020 with a superannuation balance of $300,000:

$ % Tax free component

60,000 20%

Taxable component

240,000 80%  $300,000 

Tony is aged 65 and a widower and rolls over his full balance to purchase an account-based pension. His income payments are taxfree and non-assessable income. However, if he dies and the balance is paid to his adult (non-dependent) children, 80% of the balance is paid as a taxable component and taxed at 15% (plus Medicare levy). On a $300,000 death benefit the dependants will pay tax of $40,800 ($240,000 × 17%).

Tony has worked full-time until his retirement date so he is eligible to make a contribution into super. However, he is only able to contribute up to $100,000 as a non-concessional contribution after reaching age 65 (unless he is using the balance of the bring forward cap triggered in one of the two years before the financial year in which he reached age 65). Therefore, he cashes out $100,000 from his super fund. The lump sum is split between tax-free and taxable components on a proportional basis as:

$ % Tax free component

20,000 20%

Taxable component

80,000 80% $100,000

No lump sum tax is payable on the withdrawal and he contributes the amount back into his super fund as a non-concessional contribution before starting an account-based pension. This has changed his proportional split to:

$ % Tax free component

140,000 46.67%

Taxable component

160,000 53.33% $300,000

Upon Tony’s death, only 53.33% of the balance is now a taxable component. On a $300,000 death benefit his adult children would pay tax of $27,198 including Medicare ($159,990 × 17%). If Tony was under age 65 (or within the first year that he did not meet the work test — refer contribution rules (¶4-205)) and eligible to make personal non-concessional contributions, he may have been able to implement a cash out and recontribution strategy for up to $300,000 (if triggered on or after 1 July 2017). This would have allowed him to commute the full balance and convert the accountbased pension to 100% tax-free component. Alternatively, if Tony had been still married, he could have contributed $100,000 into his account and $100,000 into his wife’s account as a spouse contribution (depending upon circumstances).

¶16-760 Commuting a pre-1 July 2007 income stream An income stream commenced before 1 July 2007 will see the underlying tax-free portion of the account balance decrease with every payment made until a trigger event occurs (¶16-720). This is because of three reasons: • the eligible service period is extended up to the trigger date, diluting any pre-1 July 83 component (which forms part of the tax-free component) • the concessional and undeducted components are reduced by the amounts paid as income until the trigger event occurs • under the pre-1 July rules all earnings in an income stream are allocated to the taxable component. Clients under age 60 with a pension started before 1 July 2007 who have not reached a trigger event (likely to now only be a younger person receiving a pension due to death or disability) may benefit from commuting (in full or part) to create a trigger event and set the proportions as a fixed amount. This can reduce tax payable on income received before age 60 as well as increase the tax-free component in a death benefit. Modelling of comparisons for the client’s individual situation is important.

Note From 1 July 2017 a death benefit pension can be commuted and rolled over to a new pension with another provider but cannot be rolled back into accumulation phase. Transfer balance cap implications may also apply (¶16-940).

¶16-770 Income stream tax offset

Income stream from a taxed fund If the client is at least preservation age but not yet age 60, a 15% tax offset is available on the taxable income paid from: • a superannuation fund which either is or has in the past been complying and is fully taxed (ie has been subject to the 15% earnings tax — see ¶4-320), or • a life company using superannuation money. The offset is not available on income streams purchased with ordinary money. From age 60 the income stream is tax-free and is not included in taxable income so a tax offset does not apply. If the client turns age 55 in a year, the offset applies to income payments received on or after their birthday. The offset also applies to taxable income stream payments which are payable due to death or permanent incapacity, regardless of the recipient’s age and transition to retirement income streams. A single person with no other assessable income and no dependent spouse or children can receive up to approximately $55,450 (for 2020/21) of taxable income from the income stream without incurring a tax liability due to the offset (includes the low income offset and low and middle income tax offset) (¶16-587). Medicare and other levies may still be payable as the offset cannot be used to pay these levies. Any excess offset can, however, be used to reduce tax payable on other income. Previous RBL excess amounts Prior to 1 July 2007, income streams may have included an amount that was excessive against the client’s relevant reasonable benefit limit. The portion of income that related to this amount was not eligible for a tax offset. Since 1 July 2007, all excess RBL amounts have been abolished and the full taxable income is eligible for a tax offset under age 60. It all becomes fully tax-free from age 60. Income stream from an untaxed fund The taxable portion of income paid under age 60 from an untaxed superannuation fund (ie unfunded public sector scheme) is fully taxable at the client’s marginal tax rate plus Medicare and other levies. Once the client reaches age 60, a 10% tax offset applies to the taxable income.

¶16-780 Taxation of commutations If a fixed term or lifetime income stream is commuted, the product provider effectively buys back the future income payments. The commutation value is actuarially determined at a rate to discount the future guaranteed income stream into a present value lump sum and to cover costs. Lump sums withdrawn from an account-based pension above the selected income stream are also defined as commutations. Classification of commutation Any amount paid as commutation of a superannuation income stream is defined as a superannuation lump sum. This amount can be taken in cash or rolled over to another income stream or back into the accumulation phase of superannuation. Superannuation lump sums are split between tax-free and taxable components (¶1-285). However, the lump sums received by a person aged 60 or older are tax-free unless they include an untaxed element. Tax may be payable by a person under age 60. The taxation of superannuation lump sums is discussed at ¶1-285. It should be noted that any death benefit lump sums cannot be rolled over and must be taken in cash. Income payment or lump sum? From 1 July 2017, income payments received from a superannuation income stream cannot be classified as lump sums for tax purposes.

Prior to this date (under reg 995-1.03(b) of the Income Tax Assessment Regulations 1997) clients under the age of 60 could choose to make withdrawals to meet the minimum income payment requirement, but then have those payments classified as a lump sum to take advantage of the superannuation lump sum low rate cap so that payments were received tax-free. This strategy is no longer available. Partial commutations can still be made from unpreserved income streams, however, these amounts do not count towards the minimum annual pension payment requirements.

¶16-800 Foreign superannuation income streams Income paid from a foreign or non-resident superannuation fund is included in the assessable income of an Australian resident. The income can include a tax-free amount if it is a contributory scheme. Contributory pensions paid under the British National Insurance Scheme to Australian residents include a tax-free amount. This tax-free amount can be calculated based on the actual components of the payment if the client wishes to provide details or the client can choose to use the blanket rule where 8% of the annual pension payment is assumed to be tax-free. In many cases, the 8% rule gives a higher tax-free amount. If the client provides the ATO with component details and a lower tax-free amount is determined, the client cannot then choose to use the 8%. Careful calculations should be made before details are provided to the ATO. Foreign income streams are not entitled to the 15% offset on taxable income (¶16-770). The income payments received are fully assessable under the social security income test.

¶16-810 Income streams from non-complying Australian funds An income stream paid from a non-complying Australian superannuation fund (¶4-340) is exempt from taxation. Non-complying funds do not receive any taxation concessions (earnings are taxed within the fund at 45% — this was temporarily increased to 47% for the three years from 1 July 2014 to 30 June 2017 due to the Temporary Budget Repair Levy), so income has already been taxed at the highest marginal tax rate in the fund.

COMPLYING INCOME STREAMS ¶16-830 Criteria for complying income streams Complying income streams were offered prior to 20 September 2007 as a strategy for receiving taxation and/or social security benefits. It was possible to structure lifetime, fixed term and term allocated pensions (TAPs) to be complying. This enabled superannuation benefits to be measured against the higher pension reasonable benefit limit (RBL) and for the income stream to be eligible for a Centrelink/Veterans’ Affairs (DVA) asset test exemption with a 100% exemption if purchased before 20 September 2004 and a 50% exemption if purchased between 20 September 2004 and 19 September 2007 (inclusive). If the income stream was only 50% exempt for Centrelink/DVA the assessable value is reduced every six months by half of the deductible amount included in income payments over that six-month period (¶16620). Terms and conditions to be complying The terms and conditions of the contract or policy must have met the standards set out in SISR depending on the date of purchase. This allowed superannuation benefits to be measured against the pension RBL (before 1 July 2007) or to receive an asset test exemption for social security. To be complying, the income stream must have been purchased before 20 September 2007 with a term: • if purchased before 20 September 2004, payable for life or if the client had reached Age Pension/Service Pension age it could be purchased for a fixed term between 15 years and life expectancy (could have a shorter term if life expectancy was less than 15 years)

• if purchased between 20 September 2004 and 30 December 2005, payable for life or a fixed term between life expectancy and the life expectancy that would apply if five years younger • if purchased between 1 January 2006 and 19 September 2007, payable for life or a fixed term between life expectancy and the number of years to age 100. Other conditions required were: • payments must be made at least annually • the first year’s payment must be fixed • indexation of income was not capped for RBL purposes and income payments may fall only if there is a negative CPI. For social security purposes, the indexation rate must be capped at the greatest of 5% or CPI plus 1% and payments cannot fall. The income for a term allocated pension could vary in line with balance changes and the payment factors • there is no RCV • the income stream could only be commuted in limited circumstances: – within first six months (but not if purchased with the commutation from another complying income stream or if purchased under the transition to retirement rules) – on the death of the owner (for lifetime income streams, this is limited to within the guaranteed period) – if the term of a term allocated pension was based on the reversionary’s life expectancy for social security purposes, commutation can only occur upon the death of both the owner and the reversionary – if another complying income stream is purchased with the proceeds, or – to pay a surcharge liability • the commuted amount cannot exceed the existing capital value of the payments commuted or the account balance • the income stream can only be transferred on the death of the client to a reversionary beneficiary • the income stream cannot be used as security for borrowings. The term of non-superannuation complying annuities An ordinary money annuity purchased in joint names had to meet the term restrictions for both owners, to qualify for social security concessions. Example Purchased between 1 January 2006 to 19 September 2007 Albert was age 70 with a life expectancy of 14.08 years and his wife Beryl was age 67 with a life expectancy of 19.49 years when they bought a complying joint annuity with ordinary money on 10 August 2007. To be complying, the term needed to meet the rules explained in ¶16-830. Albert needed to buy an annuity with a term of 15–30 years, while Beryl needed to buy one with a term of 20–33 years. For a joint annuity they needed a term within the overlap range, ie 20–30 years, to be complying for Centrelink purposes and receive a 50% asset test exemption. Purchased between 20 September 2004 to 31 December 2005 Thomas and his wife Jacinta bought a joint annuity on 10 August 2005 with ordinary money. Thomas was age 70 with a life expectancy of 14.08 years. Jacinta was age 67 with a life expectancy of 19.49 years. To be complying, the annuity term needed to meet the rules explained in ¶16-830. Thomas needed to buy an annuity with a term of 15–18 years, while Jacinta needed to buy one with a term of 20–24 years. There is no overlap in these terms, so a joint term annuity

would not be complying and would be fully asset tested by Centrelink. Purchased before 20 September 2004 On 15 September 2004, Darren was age 65 with a life expectancy of 16.21 years. Kylie, his wife, was age 65 with a life expectancy of 19.88 years. To receive an asset test exemption, they could buy a joint complying annuity using ordinary money for a term of 15, 16 or 17 years. This met the requirements for both owners as Darren needed to buy an annuity for 15–17 years and Kylie needed one for 15–20 years.

¶16-840 Commuting complying income streams Complying income streams are non-commutable. Despite the fact that RBLs have been abolished from 1 July 2007 (so the concept of a complying income stream no longer exists for taxation purposes) existing income streams remain non-commutable. They can only be commuted in limited circumstances if the money is rolled over to another comparable and non-commutable income stream. Care needs to be taken to determine if any commutation is possible under SIS rules as well as the governing rules/contracts for the income stream. If a commutation is possible, the impacts for Centrelink/Veterans’ Affairs (DVA) are important to consider because unless strict rules and processes are followed, asset test exemptions can be lost and debts could be raised to repay some of the benefits received in the previous five years back to Centrelink/DVA. Centrelink/DVA impact of commutations — retail funds A complying income stream from a retail provider or life company can only be commuted if it is fully commuted (some specific exceptions) and the full commutation is rolled over to start an equivalent income stream that meets the same requirements to be complying (including non-commutable) with a new provider. This means that: • an income stream that is 100% exempt can only be rolled over to purchase a new “complying” lifetime or life expectancy fixed term income stream • an income stream that is 50% exempt can be rolled over to purchase a new “complying” lifetime, life expectancy or term allocated pension. But even then, this commutation is only allowed if in addition, the commutation meets one of the following sets of conditions: • the reversionary has passed away and that person had a longer life expectancy (than primary owner) and was used to calculate the assessable income (full commutation) • the primary owner and reversionary have separated or divorced and this pension is split to effect a property settlement or the income stream is split to make a payment under the Family Law Act (full or partial commutation) • the income stream is a lifetime or life expectancy income stream (immediate annuity paid from a statutory fund) but does not pass the high probability test of being able to meet repayments (full commutation) • the income stream is transferred to a successor fund (full commutation) • the income stream is commuted to pay a surcharge debt or a hardship amount (full or partial commutation) • the income stream is a term allocated pension and it is rolled over to purchase another noncommutable term allocated pension (full commutation). If these conditions are met, the new income stream will retain the same level of asset test exemption as the original income stream. If these conditions are not met the new income stream will be fully assessable and a debt with Centrelink/DVA may be raised for any benefits received in additional pension payments for the previous five years.

Centrelink/DVA impact of commutations — SMSF or Small APRA fund (SAF) If the complying income stream was commenced in an SMSF or SAF, a commutation will be allowed under the same conditions as those above for an income stream commenced from a retail fund. In addition, a commutation will be allowed if: • the income stream fails the high probability test (as certified by an actuary) • the SMSF/SAF is closed due to death of the pension member, or the administrative responsibilities are too onerous due to age or incapacity of a trustee. If the SMSF or SAF complying pension is commuted in accordance with these rules the available options and outcomes for ongoing Centrelink/DVA assessment are shown in the table below. Original pension

Commutation option

Outcome

Lifetime pension or fixed term pension — currently 100% asset test exempt (ATE) but fails high probability test (as per actuarial certification)

Roll full value (including any reserves) to an equivalent complying pension with a retail provider

New pension is 100% asset test exempt and no debt is raised

Roll full value (including any reserves) to a non-commutable TAP within the SMSF/SAF or an external provider

New pension loses asset test exemption (account balance becomes fully assessable as an asset) but no debt is raised

TAP — 50% ATE

Roll full value to a new noncommutable TAP within the SMSF/SAF or an external provider

New pension retains 50% asset test exemption and no debt is raised

If a commutation is made, the full amount must be commuted (including reserves) and the full amount must be rolled over to an appropriate substitute income stream. If the full amount is not commuted, the new income stream will lose its asset test exemption and a debt will be raised. The debt is equal to the amount of additional Centrelink/DVA payments that were received due to the asset test exemption during the previous five years. If these conditions are not met the new income stream will be fully assessable and a debt with Centrelink/DVA may be raised for any benefits received in additional pension payments for the previous five years.

DEATH BENEFIT FROM INCOME STREAMS ¶16-900 Payment of death benefits Income streams have implications for estate planning. A client should be aware of the options available, what is payable and the taxation treatment of death benefits. Upon the death of the last owner of the income stream, the balance of an account-based income stream (including term allocated pension) can be paid to a SIS dependant or to the deceased’s estate. The death benefit of a fixed term income stream is the discounted value of the remaining income payments. This is an actuarial calculation. A lifetime income stream has no death benefit unless the death occurs within the guaranteed period. In this case, the death benefit is the discounted value of the income payments payable within the remaining guarantee period. Lump sum death benefits are discussed at ¶19-610. Payment options Clients have a number of estate planning options to consider when purchasing an income stream product in relation to:

• who the death benefit can be paid to • what type of death benefit nomination is required and how trustee discretion may apply • whether the benefit can be paid as a lump sum or pension • how the benefit is taxed • assessment against the beneficiary’s transfer balance cap (¶16-940). Although the options available can vary among products, the following options are common. Automatic reversionary Death benefits can only be paid as a pension to a death benefits dependant as defined by taxation law (¶19-610). This will include a current spouse, child under age 25 who is still financially dependent, a person who was financially dependent upon the deceased or a person in an interdependency relationship with the deceased. The fund’s trust deed may limit this list further. Pensions paid to a child must be commuted (to a tax-free lump sum) by the child’s 25th birthday unless the child meets disability requirements. If a reversionary beneficiary is selected, the payments automatically continue to the nominated person, provided that person meets the requirements to be a reversionary at the time of death. This option is also binding and does not leave any discretion to the trustee if the nomination is valid. The income payments are paid at the rate specified in the contract for lifetime or fixed term pension. This type of nomination generally cannot be changed without commuting the income stream and starting a new one but may depend on the provider and contract terms. If an account-based pension is paid to the reversionary, the minimum payment calculated for the original owner continues for the rest of the financial year (in which death occurs) but is recalculated based on the reversionary’s age on the next 1 July. For social security purposes, if it is an account-based pension and the deductible amount (¶6-640) was calculated based on the longest life expectancy of the client and the reversionary, the deductible amount rules will continue to apply to that pension for the reversionary beneficiary provided the: • original owner still had the pension assessed under deductible amount rules at the time of death, and • reversionary is eligible for a means tested payment from Centrelink of Veterans’ Affairs at the point of reversion and ongoing. If the deductible rules do not apply to the reversionary it will be assessed under deeming rules. Binding nomination If a binding nomination is made, the client will direct the trustee to pay death benefits to one or more of their SIS dependants or their estate. The direction must generally be updated at least every three years or it will lapse, although some funds may have a non-lapsing binding nomination that remains current until it is revoked or amended. It is important to check the terms of the trust deed, especially if it is an SMSF. A valid nomination is binding and does not leave any discretion to the trustee. Therefore it may enable the client to set up their estate plan with more certainty. It also provides flexibility as the nomination can be updated at any time if circumstances change. The nomination is generally only valid in regards to whom to pay, leaving the trustee discretion to decide whether to pay a lump sum or a pension. Pensions can only be paid to a death benefits dependant under tax law and, if paid to a child, it must be commuted to a tax-free lump sum by the child’s 25th birthday unless the child meets the disability requirements. Some funds may offer a non-lapsing binding nomination. This type does not have to be renewed every three years and remains valid unless the client amends or cancels the nomination. SMSFs do not need to comply with the rules for a public offer fund when making a binding death benefit nomination, provided it meets any specifications in the trust deed.

For social security purposes, if the pension commenced before 1 January 2015 and nominated a beneficiary under a binding nomination, the deductible amount if applicable (¶6-640) was calculated based on the owner’s life expectancy only. If a death benefit is then paid to the beneficiary (commencing after 31 December 2014), the beneficiary will have assessable income calculated under deeming rules. Non-binding nomination Clients can nominate a beneficiary under a non-binding nomination. This provides a guide to the trustees but is not binding. The trustee still has full discretion to decide whom to pay. The trustee will also have discretion over whether to pay the benefit as a lump sum or a pension (if paid to a death benefits dependant). If paid as a pension to a child, it must be commuted to a lump sum by the child’s 25th birthday unless the child meets the disability requirements. For social security purposes, if the pension commenced before 1 January 2015 and death benefits are to be determined under a non-binding nomination, the deductible amount if applicable (¶6-640) is calculated based on the client’s life expectancy. If a death benefit is then paid to the beneficiary (commencing after 31 December 2014), the beneficiary will have assessable income calculated under deeming rules.

¶16-910 Taxation of death benefit income stream The taxation of a reversionary income stream paid upon death to a dependant will depend on the age of the original owner and the dependant. The pension is counted against the recipient’s transfer balance cap (¶16-155 and ¶16-940). From taxed source Any tax-free amount is received tax-free. The taxable portion of income is taxed as follows:

Original owner under age 60 Original owner aged 60 or over

Dependant under age 60

Dependant aged 60 or over

Taxable with 15% offset

Tax-free

Tax-free

Tax-free

If the income stream is taxable to the dependant, a new TFN declaration form must be completed and TFN provided. From untaxed source Any tax-free amount is received tax-free. The taxable portion of income is taxed as follows:

Original owner under age 60 Original owner aged 60 or over

Dependant under age 60

Dependant aged 60 or over

Taxable

Taxable with 10% offset

Taxable with 10% offset

Taxable with 10% offset

Transfer balance cap interaction A death benefit paid as an income stream will trigger a credit in the transfer balance account of the beneficiary. These rules are discussed at ¶16-940.

¶16-920 Commutation of death benefit income stream Death benefits can only be paid as an income stream to someone who qualifies as a death benefits dependant (under taxation law). If paid to a child, the pension must be commuted to a tax-free lump sum by the child’s 25th birthday unless the child meets the disability requirements (¶16-930). From 1 July 2017, the death benefit income stream can only be commuted to: • pay a lump sum which is withdrawn from the superannuation system

• a lump sum that is rolled over to directly start a new death benefit pension with a new provider. Taxation of commutation If the income stream is commuted it is deemed to be a death benefit superannuation lump sum and is paid tax-free. This amount cannot be rolled back into accumulation phase of superannuation. To get it back into accumulation phase, it must be contributed as a new contribution and will be subject to preservation requirements. Prior to 1 July 2017, if a death benefit income stream was commuted more than the later of six months from date of death or three months from granting of probate the resulting lump sum was treated as a superannuation lump sum of the beneficiary. A spouse could rollover this amount to the accumulation phase of super or another income stream as an unpreserved amount. This option is no longer available.

¶16-930 Child account-based pensions Death benefits can be paid as an income stream to a child: • under age 18, or • aged 18–25 who is financially dependent, or • who meets the permanent disability requirements. The taxable portion of the income is taxable to the child at normal adult marginal tax rates, with a 15% tax offset. This allows the child to receive up to $55,450 (for 2020/21) before tax is payable. Medicare may still be payable. The pension must be commuted to a lump sum by the child’s 25th birthday unless the child meets the disability definition under s 8(1) of the Disability Services Act. The lump sum is paid tax-free and cannot be rolled over. Impact of child pension on transfer balance cap When a child receives a death benefit income stream upon the death of a parent, they will have a transfer balance account set up to assess the value of the income stream. However, a modified transfer balance cap applies instead of the general transfer balance cap (¶16-155). The modified balance is based on the deceased parent’s pension phase interests received by the child. This is effected through a series of transfer balance cap increments and depend on when the death benefit income stream started. If the income stream started to be paid as a death benefit before 1 July 2017, the modified cap is the same as the general transfer cap, ie $1.6m in 2017/18 to 2020/21. If the income stream started to be paid as a death benefit on or after 1 July 2017, the modified cap depends on the parent’s circumstances as shown in the table below. Deceased parent’s circumstances

Child’s transfer balance cap (death benefits paid from 1 July 2017)

Full balance of superannuation interests If sole beneficiary, child’s cap is equal to the general transfer in accumulation phase (no transfer balance cap (currently $1.6m). balance account) If not the sole beneficiary, the child receives a proportion of the transfer balance cap equal to the proportion of their share of the parent’s super benefit. Death benefits that exceed the applicable cap need to be taken as a cash lump sum. Full balance of superannuation interests The child’s transfer balance cap is equal to their share of the in pension phase parent’s super benefit. No excess transfer benefit will be created.

Superannuation interest is split between If child’s benefit is paid only from accumulation phase, the accumulation phase and pension phase child’s transfer balance cap is nil. If child’s benefit is paid from both accumulation and pension phase, the child’s cap is equal to their share of the retirement interest. Death benefits paid from the accumulation phase would create an excess transfer benefit if taken as an income stream, so it must be taken as a cash lump sum. When the child turns age 25, any remaining balance in the death benefit pension needs to be commuted to a lump sum (unless the child meets the disability requirements). At this point, the transfer balance account ceases. When the child meets a condition of release for their own superannuation savings, they will commence a new transfer balance account and be entitled to the full transfer balance cap.

¶16-940 Transfer balance caps and death benefit income streams From 1 July 2017, the amount that can be transferred and held in the tax-free retirement income phase is limited by the transfer balance cap. The general cap is $1.6m for 2017/18 to 2020/21. The cap includes amounts accumulated by a person in superannuation that are rolled over to start a retirement phase income stream (¶16-155) as well as death benefit income streams received. If a death benefit income stream starts to be paid, a credit will be added in the recipient’s transfer balance account. If the income stream is paid under an automatic reversionary option, the credit does not arise for 12 months from the date of death and is the value on that date. This allows the recipient time to consider options and to make changes, if necessary, to bring their account back under the cap amount. If it is a non-reversionary income stream, the credit arises at commencement of the reversion. The rules are different for a death benefit income stream paid to a child (¶16-930). Example Barbara and her husband Douglas, retired in May 2016 and started account-based pensions for $1m each. They each nominated their spouse as an automatic reversionary. On 1 July 2017 the balances had increased to $1.1m and this created a credit for each of $1.1m in their respective transfer balance accounts. Douglas passed away on 10 October 2020 and his account-based pension commenced to be paid to Barbara as an automatic reversionary pension. At the date of death, Douglas’ pension still had a balance of $1.1m. This pension will create a credit in Barbara’s transfer balance account but not until 10 October 2021 and will be based on the balance at that point. The 12-month delay gives Barbara time to assess her options because if both pensions continue, she will exceed the transfer balance cap. Barbara can choose to commute some of her own pension before the 12-month period expires and roll it back into accumulation phase or take a cash lump sum. Alternatively, she can choose to commute some of Douglas’ pension but this commutation can only be taken as a cash lump sum and invested outside the superannuation system or used to make a contribution back into accumulation phase (if eligible under contribution rules).

Commutations of death benefit income stream From 1 July 2017, death benefits can be commuted and rolled over to another fund to commence a new death benefit income stream. The new pension retains the death benefit tax treatment. However, from this date, a commuted death benefit income stream can no longer be rolled back into accumulation phase. Prior to 1 July 2017, a death benefit income stream that was commuted more than the latter of six months from date of death or three months from date of probate grant created a superannuation lump sum that could be rolled back into accumulation phase by eligible beneficiaries. This is no longer possible. The rules are different for a death benefit income stream paid to a child (¶16-930). Pre-1 July 2017 death benefit income streams Death benefit income streams that commenced before 1 July 2017 are assessed against the transfer

balance cap. If the income stream was paid as an automatic reversionary, the credit in the transfer balance account was applied on the latter of 1 July 2017 or 12 months from the date of death. The value of the credit was the balance as at the end of 30 June 2017. If the income stream was paid as a non-reversionary, the credit was applied on 1 July 2017 for the balance as at the end of 30 June 2017.

RETIREMENT LIVING AND AGED CARE The big picture

¶17-000

Retirement living and aged care options

¶17-010

The value of financial advice

¶17-015

Accommodation options for ageing clients

¶17-020

Downsizing

¶17-025

Granny flat interests

¶17-030

Home care Receiving services and support at home

¶17-100

Commonwealth Home Support Programme (CHSP)

¶17-110

Home Care Packages (HCP)

¶17-120

Independent living arrangements Independent living arrangements and retirement villages

¶17-200

Retirement villages

¶17-210

Supported Residential Services (SRS)

¶17-220

Independent living units

¶17-230

Social security assessment and costs of retirement villages ¶17-240 Residential aged care Residential aged care facilities

¶17-300

Residential care and the entry process

¶17-310

ACAT assessment

¶17-320

Entering care

¶17-330

Calculating aged care costs

¶17-340

The family home and aged care

¶17-350

Changing aged care facilities

¶17-360

Respite care

¶17-370

Financial hardship assistance for aged care

¶17-380

¶17-000 Retirement living and aged care

The big picture With an ageing population, an extensive range of lifestyle options are now available for elderly clients. Each option has financial implications which need to be taken into account when providing advice, and as far in advance as possible. This chapter provides a detailed explanation regarding common retirement living arrangements, home care services and aged care options. Advisors who provide financial advice to aging clients should have knowledge of the array of choices

available, and the costs and other implications involved with each. Prior to entering aged care facilities, there are still a range of other living arrangements ageing clients can choose that will allow them to downsize from the family home. Often this may involve moving in with an immediate family member (such as an adult child) or other relative. We explore some of these options in this chapter. Many of the arrangements highlighted and decisions which may be made could be entered into many years before residential care is considered. Often, this could be without consideration of future social security, aged care, and estate planning implications. This means it is important to be having conversations with clients as early as possible to understand their future intentions, and on an ongoing basis. Other options such as retirement villages, independent living units and supported residential services are also lifestyle choices with the potential to provide some low care assistance. Advisers need to understand the entry costs, ongoing fees and often high exit costs when assisting clients who wish to downsize from the family home. Centrelink/Department of Veterans Affairs (DVA) benefits need to be reviewed particularly when the family home is sold to fund these arrangements. Depending on the particular arrangement, the government may or may not be involved with subsidising and regulating fees and services. Further, the regulation may be the responsibility of either state governments or the federal government. “Aged care” is a term most easily understood as being nursing homes and home care. It may also refer to community services, specific geriatric health care and community centres. In July 2014, a revised Aged Care Act (Living Longer Living Better) was introduced. New rules apply for residents who entered care from 1 July 2014. While this chapter focuses predominantly on post-1 July 2014 arrangements, notes are included to highlight important differences which may apply to your clients who entered care before the changes. Residential aged care is the final part to this chapter. The legislative changes are summarised and also detailed explanations on the array of aged care costs with case studies are provided. Centrelink/DVA rules changed on 1 January 2017 for the assessment of rental income on the home. Keeping and renting the family home may now be far more difficult, and for new entrants, concessions are not available on the rental income or value of the home for means testing as they previously were. For social security purposes, the family home is assessed like an investment property two years from vacating the home and moving into an aged care facility. For many, social security payments still remain an important part of income relied upon to help fund aged care. It is therefore important to understand Centrelink’s assessment of the family home and the change in pension payments that coincide with entry into aged care. Advisers have the potential to add great value and be of assistance to clients in this complex area of advice. The Services Australia and My Aged Care websites are good resources for information regarding: • home care services and packages • home care fees • aged care facilities • aged care fees, and • the aged care process. See: www.myagedcare.gov.au and www.servicesaustralia.gov.au. Summary of information provided Outline of the range of potential changes in living arrangements for aging clients.................................................................. ¶17-010

Highlighting the value of financial advice as it relates to aged care.................................................................. ¶17-015 Granny flat interests — implications and considerations.................................................................. ¶17-030 Home care options.................................................................. ¶17-100 Independent living arrangements.................................................................. ¶17-200 Overview of residential aged care.................................................................. ¶17-300 Entering Aged Care.................................................................. ¶17-330 Aged care fees and costs explained.................................................................. ¶17-340 Aged care and the family home.................................................................. ¶17-350 Changing aged care facilities.................................................................. ¶17-360 Respite care.................................................................. ¶17-370 Hardship assistance for aged care.................................................................. ¶17-380

¶17-010 Retirement living and aged care options For most senior Australians, the thought of having to leave their home and enter aged care accommodation can be a daunting and confusing experience. Planning for the lifestyle changes ahead, right through to the financial aspects, needs to be addressed earlier rather than later. This applies for selffunded retirees as well as pensioners. With an ageing population, financial advisers have an increasingly important role to play when it comes to helping clients understand the financial impacts associated with a change in their accommodation. This includes not only the immediate financial outcomes, but also the current and future taxation, social security, aged care and estate planning ramifications. Initially, decisions by an ageing person to downsize may be based on lifestyle choices. However, the older and more frail the individual becomes, the more likely the change to their lifestyle may be driven by their health and mobility needs. From a financial advice perspective, this will often mean that at the time financial advice is provided in relation to aged care, the person will either have moved into an aged care facility already, or the move will be otherwise imminent, perhaps directly from hospital. This only adds to the complexity of aged care advice, because: • the client/s and their family are likely to be very emotional • the client may have moved into a room that they cannot actually afford • where the person moving into care no longer has mental and legal capacity (for example, because they have dementia), it can be quite difficult to review and implement appropriate changes to estate planning arrangements, including Enduring Powers of Attorney and Guardianship • a resident has generally 28 days to return the Accommodation Agreement and elect how they wish to pay certain fees, and • it can be difficult to have a robust discussion about the former family home at a time that is already highly emotional. In relation to the provision of community and aged care services, there are a range of options available, starting from home help through to aged care residency. Each option may or may not have governmentfunded assistance. Each choice will have a different financial impact, particularly pertaining to Centrelink/DVA benefits.

¶17-015 The value of financial advice As the population ages, more and more clients will require some kind of aged care advice — perhaps if not for themselves, for ageing parents. The first step is not always directly into a residential care facility (ie a nursing home), and a number of changes to a person’s accommodation arrangements may take place well before this often “final step”. It is important to understand and plan for these changes well in advance to ensure that the “next step” remains affordable. The cost of aged care can be significant. From a strategic planning perspective, it is important for advisers to understand the lifestyle and health care options available and to educate their clients in advance. Advanced planning not only provides peace of mind in knowing a person can afford the necessary health care services available many years into the future, but it may also provide greater scope to implement certain strategies to help to more effectively manage costs. Often, a client’s goals and objectives will be driven just as much, if not more, by lifestyle and estate planning outcomes, compared to financial outcomes. While it is obviously important to ensure that the costs of care can be met, it is not uncommon for a client’s main priorities to be: • funding a room in a particular residential care facility (due to geographic location, cultural considerations or because the person’s spouse is in the same facility) • to continue to provide accommodation in the former family home for a family member or other dependents, or • to retain the family home for estate planning purposes. This means that the goal is not always to minimise fees, or to maximise the value of the estate. Steps prior to residential care It is natural for a person to want to retain independence for as long as possible. This means that before residential care becomes a consideration, a person may look at alternatives such as: • moving in with a family member • building a granny flat on an adult child’s block • having family move into their existing home • receiving home care services • downsizing, or • moving into a retirement village. Each of these options requires careful and holistic planning. Entering residential care The process of entry itself can be overwhelming. It is a very emotional time for the person moving into care as well as their family, and a lot of important decisions will need to be made at this time. It can be difficult for clients to fully appreciate the gravity of some of these decisions, and to consider decisions not only in isolation, but also with consideration of the social security, taxation, fee, and estate planning implications. The framework that applies to aged care fees is complex, and information is not always passed on by facilities in a clear, accurate and concise manner. There are a number of steps involved, and significant value can often be provided by assisting clients and their families through this process.

¶17-020 Accommodation options for ageing clients There may come a time when living alone at home is no longer an appropriate option. A decision to

change living arrangements may be voluntary or involuntary. There may be a natural progression from one accommodation option to another, before finally entering a residential aged care facility, or a person may stay in their home, moving directly into full time care when the need arises. Changes to accommodation arrangements may be initiated when for example: • home maintenance becomes too much • one member of the couple passes away • there is a need or desire to be closer to family, or • when health and mobility deteriorate. Initially, alternatives may be considered, such as downsizing, or moving in with family members. Each option should be given careful consideration. There may be consequences in relation to social security and other financial objectives. In addition, where a person will eventually require full time care in a residential care facility, it is important to understand how any prior arrangements may impact any aged care fees payable.

¶17-025 Downsizing When living in the family home becomes too much, downsizing to something more appropriate may be one of the first considerations. It may be one of the more preferable first options, as it enables a person to retain some independence, in a more manageable environment. Before a person downsizes their home, it is important to consider social security, taxation, and other cost implications. Revisiting estate planning should also be prioritised. Social security For social security purposes, a person’s main residence is an exempt asset for means testing. This means that if a person sells their family home, and ends up with residual sale proceeds after the purchase of a new property, their pool of assets subject to means testing would increase, and therefore may have an impact on their entitlements. A concession may apply for up to 12 months (or up to 24 months in certain circumstances) where a person sells their main residence, and intends to use the sale proceeds to purchase, build, repair or renovate a new main residence. The 12 month exemption applies only from an assets test perspective, and is limited to the amount of the sale proceeds that the person genuinely intends to apply to the purchase or construction of their new main residence. The entire amount will be immediately subject to assessment under the income test. For example, if all of the proceeds are held in cash, the full amount of proceeds would be deemed as a financial investment. More information can also be found by visiting the Guide to Social Security Law online: 4.6.3.80 Exempting the Principal Home at guides.dss.gov.au/guide-social-security-law/4/6/3/80 If there is no intention to purchase another dwelling that the person will occupy as their main residence, the full amount of sale proceeds will generally be assessable immediately for both the income and assets test. Note that payment of a lump sum accommodation fee to a residential care facility does not qualify for

the exemption. Downsizer super contributions Since 1 July 2018, it may be possible for a person selling their main residence (or another qualifying dwelling) to contribute sale proceeds to superannuation as a “downsizer contribution” if they are 65 or over. Limits and other eligibility criteria apply (¶12-710); however, unlike other voluntary contributions, there is no work test requirement and no total super balance limitations in relation to making the contribution. It is important to note however that the amount contributed is not concessionally treated for social security purposes. As is ordinarily the case, an amount in super accumulation phase (for a person who has reached their Age Pension age) is assessed as a financial asset, and subject to full assessment under the assets test, and is deemed under the income test. Amounts converted to an income stream are also subject to assessment, regardless of age (¶4-222).

☑ Tip Ordinarily a person is unable to make personal super contributions after reaching age 67 unless a work test has been met (or the work test exemption is able to be applied). Also, subject to age-based restrictions, there may also be a limited opportunity for retirees to utilise the bring-forward rule to make large non-concessional contributions to execute strategies such as the recontribution strategy to help manage future death benefit tax for non-tax dependant beneficiaries. A downsizer contribution may provide an opportunity to effectively execute a recontribution strategy, even where the sale proceeds are earmarked for other purposes.

Tax and other costs Advice should be sought to understand whether or not capital gains tax (CGT) will be payable upon the disposal of the dwelling. While a residence that has always been treated as the main residence for tax purposes is not subject to CGT, a partial CGT liability may arise if the main residence exemption is only applied in part (see ¶12-050). Stamp duty may also be a significant cost upon the purchase of a new dwelling. Certain states may provide concessions in certain circumstances. The office of State Revenue in the applicable location should be contacted to confirm whether any concessions apply.

¶17-030 Granny flat interests An increasingly common alternative exists where an elderly person either moves in with family, builds a granny flat on a family member’s property, or enters into another arrangement to reside with family. Often, this involves the adult children. A “granny flat” is often understood to be a separate, self-contained dwelling built on a property. However for social security purposes, the term has a more broad application. Broadly, for Centrelink purposes, a granny flat interest exists where a person transfers cash or other assets to another person in return for the legal right to accommodation in a dwelling. Granny flat interests have their own assessment rules for social security purposes. Depending on the circumstances, establishing a granny flat interest may help manage aged care costs, and social security entitlements. However, care should be taken to fully understand the implications of entering into an arrangement, and a reduction in fees and beneficial social security outcomes should not be the single motivating factor. There are significant estate planning considerations and potential tax consequences that should be thoroughly discussed and advised on prior to entering into any arrangement. What can a granny flat arrangement look like?

A granny flat interest does not require the dwelling to be a granny flat structure, as the term is usually defined. A granny flat interest extends to any residence that is treated as the person’s principal home, where the person has: • transferred legal ownership of the property but retained a right to accommodation for life, or • transferred assets to another individual in return for a right to accommodation for life in a specific dwelling. A granny flat interest can take on a number of forms, including where: • the title of the person’s existing home is transferred • a new dwelling is purchased in the name of another person (such as an adult child), where the elderly person makes a contribution of capital • the individual pays for the construction of a physical granny flat on another person’s property, or • the individual moves into a relative’s existing dwelling. In each of the above circumstances, a right to accommodation for life must be provided or retained. This is treated as “valuable consideration”, and it is for this reason that subject to certain rules, the transfer of cash or assets in relation to the establishment of a life interest in accommodation may not assessed as a gift (and therefore assessed under the deprivation rules). It is important to understand that a person who has any legal ownership of a dwelling, either individually, or as joint tenants or tenants in common, cannot also have a granny flat interest. This is because their right to occupy is due to legal ownership, rather than a contractual life interest. While there is no requirement that the agreement be in writing, it is recommended that a formal agreement be signed, to avoid any uncertainty. This may be important for social security purposes if a person is required to substantiate the arrangement. It is also important for other purposes that any expectations and responsibilities of each of the parties is clearly documented and understood by all involved. There are also many important estate planning issues which need to be considered before entering into a granny flat arrangement. The importance of this is amplified where the ageing client has multiple beneficiaries or dependents, and a significant portion of their assets are transferred to one individual. The way in which Centrelink values a particular granny flat interest and assesses the value for means testing purposes will vary, based upon the form in which the interest takes. In some circumstances, if Centrelink determines that the value of assets transferred in return for the right to occupy a dwelling is excessive, the deprivation rules may apply (see ¶6-670). The valuation of different types of granny flat interests is discussed in more detail below. Determining the value of a granny flat interest The way in which the granny flat arrangement is “valued” for social security purposes will depend on the nature of the arrangement. Generally, it will be valued either as the amount “paid” for the interest, or Centrelink will determine a different value based on a formula. These two approaches are explained below. 1) Amount paid as the value of the interest If this assessment applies, broadly, the value of a granny flat interest is taken to be the “amount paid” (or the value of consideration provided) for the interest. If this is accepted, there is no deprivation deemed to have occurred upon transfer. Generally, the value of a granny flat interest is accepted to be the value of assets transferred or amount paid, where the social security recipient: • transfers title to their home, and no other assets

• pays only the cost of construction of a granny flat on another person’s property, or • pays no more than the purchase price of a new dwelling, but the purchase is made in another person’s name. If however, in addition to the above, additional amounts of cash or other assets are transferred, the reasonableness test will generally be applied to determine whether any deprivation has occurred. Those without a history of homeownership, or who have only in very recent times become homeowners, who enter into a granny flat arrangement may have their circumstances assessed differently. 2) The reasonableness test Where the reasonableness test is used, the maximum amount which Centrelink will accept as the value of the granny flat interest will be determined based on a formula. This will then be compared to the value of the assets actually transferred, to determine whether deprivation has occurred. Examples of cases where the reasonableness test is used include where: • the person transfers title to their home (or purchases property in another person’s name) and transfers additional assets or pays more than the purchase price • the person pays the cost of constructing a granny flat on someone else’s property, and transfers additional assets • assets or money are transferred, but no purchase or construction costs for the home they are moving into have been incurred (such as moving into a child’s existing home). In these cases, Centrelink calculates a “reasonable amount” (see below). If the value of the assets transferred is greater than the amount calculated, then any excessive amount is treated as having been gifted and deprivation has occurred. Reasonableness amount

=

combined annual couple rate

x

conversion factor pension rate

The combined annual rate of pension (including supplements) is used, regardless of whether the person is single, or a member of a couple. The conversion factors are based on the Australian Life Tables published by the Australian Government Actuary and can be found in the guide to Social Security Law on the Department of Social Services website at guides.dss.gov.au/guide-social-security-law/4/6/4/60. Social security means test assessment of granny flats The amount a person pays to establish their granny flat interest is referred to as the “entry contribution” (EC). The EC is then assessed against a threshold, known as the “extra allowable amount” (EAA) to determine whether a person is a homeowner or non-homeowner, and whether the EC is an assessable or nonassessable asset. The EAA is the difference between the non-homeowner and the homeowner asset test limits at a time ($214,500 as at 1 July 2020). See ¶20-550 and ¶20-560 for asset test limits. If the amount paid towards the granny flat interest is more than the EAA, then the pensioner is assessed as a homeowner, and the EC is an exempt asset. If the EC is less than or equal to EAA, then the pensioner is a non-homeowner, and the EC is assessed as an asset. The person may also be entitled to Rent Assistance. Entry contribution amount

Assessment

Equal to or less than EAA

– Non-homeowner – Entry contribution assessed as an asset – Rent assistance may be payable

More than EAA

– Homeowner

– Entry contribution exempt asset (unless deprivation applies) – No rent assistance payable

⊠ Trap If a person stops living in the granny flat within five years, Centrelink will review the circumstances of the case. If the reason for leaving the granny flat was anticipated at the time the arrangement was established, such as an illness or injury which has progressed, and the person to whom the right to accommodation was granted vacates the granny flat interest, deprivation rules may apply.

Example The following example illustrates the valuation of a granny flat interest. John is a 70-year-old widow and has been living in Sydney. He recently decided to sell his family home as it is becoming too much for John to maintain. John has discussed two options with his eldest daughter Erin. John could either move into the spare bedroom in Erin’s existing double story home, or they could look to purchase a new single level property, which may be more appropriate for John and his restricted mobility. John sells his home and after associated expenses, is left with $700,000 in a bank account, and a car worth $3,500. Option 1: John moves in with Erin John moves in with Erin, and transfers $650,000 to Erin in return for a legal right to occupy a room in her dwelling. In this case, the reasonableness test will be applied to determine whether or not any portion of the amount transferred will become assessable by Centrelink. The reasonableness amount is calculated as follows:

Reasonableness amount

= combined annual couple x conversion factor pension rate

where:

Combined annual couple pension rate (including supplements)

$37,013.60

John’s conversion factor (next birthday)

16.56

Reasonable amount

$612,945.20

Therefore, John has in fact gifted:

$650,000

Less: reasonable amount

($612,945.20)

Amount gifted

$37,054.78

* Calculations are based on rates and thresholds as at 1 July 2020. John is assessed as a homeowner, and the value of the granny flat within the reasonableness test limits is an exempt asset. Note —$10,000 may be assessed as a gift, within the allowable gifting limits. The result is that a deprived amount of $27,055 is assessed as a financial asset in his income and assets tests for the next five years. In five years, the gifting would no longer be included as a deprived asset. John could also apply for home package assistance when his health begins to deteriorate to assist him to stay in his granny flat longer and potentially mitigate a move into an aged care facility. If he does so, the deprived asset would be taken into consideration when determining home care fees payable (there is no assets test but deemed income on the deprived asset would be included when calculating the income tested fee). Option 2: New home purchased in Erin’s name John and Erin agree that Erin’s existing home is not an appropriate solution longer term. The significant number of stairs in the home mean that John’s declining mobility will be problematic. Erin sells her existing home, and they purchase a new dwelling on a single level. John pays the full purchase price of $650,000, and the home is purchased solely in Erin’s name. John does not transfer anything additional to Erin. John and Erin enter into a formal agreement that provides John with a legal right to occupy the dwelling for the rest of his life. In this case, Centrelink accept that the value of the granny flat interest is the $650,000 paid (the EC). The reasonableness test is not applied. Because $650,000 is greater than the EAA, the amount is exempt, and John continues to be assessed as a homeowner.

If on the other hand, John paid not only the purchase price, but transferred an additional $50,000 to Erin, the reasonableness test would be applied, and based on the reasonable amount calculated, deprivation would be taken to have occurred.

Is establishing a granny flat interest the right thing to do? Before establishing a granny flat interest, it is very important that the client receives comprehensive, professional advice, and is fully aware of the ramifications of entering into a granny flat arrangement. This should include specialist legal and taxation advice. Establishing a granny flat right means in most circumstances, that the individual is transferring legal ownership of a significant portion of their wealth, to another individual. Often, this can be entered into without a full appreciation of future implications. Some additional considerations include: • will stamp duty, capital gains tax or other taxes and duties be payable upon transfer? • can ongoing living expenses, such as medical bills, still be met? • will it be possible to meet future aged care expenses, in a preferred facility? • who is responsible for ongoing utility bills, and home maintenance expenses? • are there any family planning or asset protection considerations? • if entering into an arrangement with one of multiple beneficiaries, are adjustments to an existing will required? • if transferring significant assets to one child in return for a right to occupy their home, how will the estate be equalised?

HOME CARE ¶17-100 Receiving services and support at home Receiving care in an existing home is an attractive option for many people. Again, independence is retained, and a person can receive the care and services they require in the comfort of their own home. Services may either be sourced privately, or where a person qualifies, home care may be accessed via a government subsidised arrangement. The types of services available vary, and may be tailored depending on the level of care the person requires. The types of services available range from help with domestic duties (such as gardening, cleaning and other home maintenance), through to personal care (help with daily personal duties), through to some nursing services. There are several broad options for home care services. Assessment is required to access government subsidised services. Private service providers also operate. These private providers are not government subsidised and therefore no government assessment will be required.

¶17-110 Commonwealth Home Support Programme (CHSP) The Commonwealth Home Support Programme (CHSP) is an entry level home support service for older people who are still managing well at home, but need some extra assistance. The CHSP is generally provided for people who are at least age 65, with the intention of improving function or capacity, or to avoid further deterioration in health. It may be available from age 50 to certain individuals including those who are low-income earners or homeless, and even earlier access is available for Aboriginal and Torres Strait Islander applicants. Services available Available services may include: • delivered meals and assistance with food preparation

• personal care • nursing and therapy services • respite care • home maintenance and modifications, and • community transport. Cost of CHSP The service is subsidised by the government, but clients have to pay some fees. Each provider is required to set their own fee contribution policy. A care receiver’s fees will be determined with consideration of their financial circumstances and ability to pay, as well as the types of services accessed. Assessment and access Clients should contact My Aged Care (Ph: 1800 200 422 or www.myagedcare.gov.au) to apply for an assessment. An application can also be completed online. The assessment will be carried out by the Regional Assessment Service (RAS) who will come to the client’s home to assess which services they can use under the CHSP. A review will then be completed every 12 months to ensure the level of services provided continues to be appropriate. If a change in services is required as determined during an ongoing care discussion, a review assessment will be completed. The CHSP services are similar to level 1 – 2 of the Home Care Packages (HCP). Clients need to choose wisely when transferring from CHSP to a level 1 or 2 HCP, as the level 1 or 2 may be more expensive than their current CHSP particularly if they are part pensioners and have to pay an income tested fee. Differences between CHSP and HCP CHSP

HCP

Set range of services with little flexibility

Case managers work out a care plan based on the client’s needs. Much greater range of services available

Clients pay for what they use

Government funding is provided to the client based on the level of care appointed to the client

Flexible to start and stop services

Eligibility is assessed by the Aged Care Assessment Team (ACAT). Bookings are made via the My Aged Care website

Assessed by Regional Assessment Service (RAS)

To increase either time or other services requires approval from an ACAT team with a visit to your client’s home to ascertain the severity of the decline in health. ACAT team will then reassess the situation and match the new level of funding required

¶17-120 Home Care Packages (HCP) A Home Care Package is an alternative to the CHSP. Depending on an individual’s needs, a HCP may provide more appropriate care where the care needs are higher. Assessment and access To be eligible to receive a HCP, an individual must first be assessed and approved by ACAT. The ACAT assessors allocate the level of care based on needs and circumstances of the individual. A national queue has been established to assign home care packages via the My Aged Care website. On this basis, the allocation of packages is dependent on the needs and circumstances of individuals. When the client reaches the top of the queue, they will be allocated a home care package with the level of

funding available. Clients who receive a package are provided with a unique referral code which stays with them allowing the package to be portable. Clients are encouraged to research and negotiate with providers using the My Aged Care website which provides a comparative analysis tool for providers services and the fees that they charge. Type of care and services available There are four levels of home care packages that provide a continuum of home care options covering basic home care all the way through to complex home care. The system has been significantly reformed to allow the consumer to tailor the care and services they prefer and to move easily between care levels as their care needs change. This is referred to as “Consumer Directed Care”. Home Care Level 1

Supports people with basic care needs

Home Care Level 2

Supports people with special needs such as those non-English speaking background, Aboriginal and Torres Strait Islanders communities and rural or remote areas

Home Care Level 3

Supports people with intermediate care needs

Home Care Level 4

Supports people with high care level needs and dementia

Cost of a HCP Each level of home care package receives a different subsidised amount from the federal government. This amount is paid to the selected approved home care providers. The subsidy contributes to the total cost of the services and care delivery. Funds can be spent on most things that relate to the individual’s care and wellbeing. The services that the individual choose need to fit within the packaged budget and listed in the tailored care plan. If clients need more services above their nominated level of care, they can pay for the additional services from their personal funds. To facilitate pricing transparency, service providers must publish a pricing schedule for services on the My Aged Care website, which must be reviewed annually, and kept up to date. A copy of the pricing schedule must also be provided to new recipients of home care services and providers must charge care receivers no more than what is identified in the schedule. Home care package fees Currently, care recipients receiving a home care package may need to pay: • a basic daily care fee • an income tested care fee (ITCF), and • an additional amount for any services accessed that are not covered by the package assigned. Basic daily fee The basic daily care fee is payable by all individuals receiving a home care package. The basic daily care fee is determined based on the level home care package received. The maximum basic daily fee applicable for each package level as at 1 July 2020 is as follows: Package level

Maximum basic daily fee

Level 1 package

$9.63

Level 2 package

$10.19

Level 3 package

$10.48

Level 4 package

$10.75

The maximum rate for a level 4 package is 17.5% of the single basic Age Pension. Income tested fee

An ITCF is payable if an individual’s income is above a certain threshold. The ITCF is calculated by Services Australia and increases the more income a person receives. The government subsidy towards the package reduces by the same amount as the ITCF.

Note Care recipients who entered care prior to 1 July 2014 who currently receive a care package and decide to change packages levels or providers will not be charged an ITCF. If a person stops receiving care for more than 28 days and then re-enters the care package they will be eligible to pay the income tested fee if applicable.

A care recipient will only be asked to pay an ITCF if their income is above the income-free threshold. Where a person does not provide details of their income to enable the ITCF to be calculated, they will be charged for the cost of the services received, up to the annual cap that applies for the ITCF. A lifetime cap also applies. For part pensioners, an individual’s ITCF will be based on the lowest of: • 50% of their income above the income threshold • the cost of their care, or • the daily cap, which is $15.43 per day (as at 1 July 2020). For self-funded retirees, their ITCF will be the lowest of: • the daily cap for a part pensioner PLUS 50% of their income above the income for a part pensioner • the cost of their care • the daily cap, which is $30.86 per day (as at 1 July 2020). For current rates, see ¶20-580. Full pensioners will not have to pay the income tested fee. The ITCF =  ITCF = (assessable income* − income free area) × 50%  *Assessable income includes income as assessed under Centrelink/DVA rules and Age/Service Pension income (excluding minimum Pension Supplement and Energy Supplement). The income free areas, as at 1 July 2020, are: $27,840.80 pa — Single $21,606.00 pa — Couple (each) $27,320.80 pa — Illness Separated (each). The ITCF has separate annual indexed cap amounts for part pensioners and self-funded retirees. When a recipient reaches the annual cap, they will stop paying the ITCF until the next anniversary of their entry date. The ITCF also has a lifetime cap and when they reach this cap, they will no longer pay the ITCF. When a recipient moves into aged care the accumulated amount paid in ITCFs will be added to the means tested care fees and count towards the lifetime cap. Example

Paul has early onset dementia. He has just been issued with a basic care package (level 1). This will provide him with approximately four hours of home help including house cleaning and taking Paul to his local shopping centre. Paul prefers not to receive meals on wheels as he has an active social life with friends dropping by to take him to various memberships and clubs he is involved in. Paul receives a partial Age Pension as he receives a Commonwealth Super Scheme (CSS) pension. His asset and income position is as follows:

Assets Home (not assessed)

$800,000

Bank account

$150,000

Income Deemed income from bank account*

$2,315

Assessable income from CSS

$13,260

Centrelink Age Pension (less supplements)

$17,739.30

Total Income*

$33,314.30

(*Remember the social security rules apply to determine income assessment. Therefore deemed income will be assessed, not interest income. The deeming rates that apply from 1 July 2020 of 0.25% and 2.25% have been used for this calculation). The cost for the home care assistance for Paul will be as follows: $9.63 pd Basic Care Fee $7.50 pd Income Tested Fee * Calculations are based on rates and thresholds as at 1 July 2020.

The My Aged Care website has a home care package provider comparison, which allows consumers to compare fees. If Paul requires more care than the government provided subsidised care, he can request additional services from the provider for an arranged private fee. Paul is not precluded from receiving more private assistance in combination with the packaged care. The home help may therefore delay his transition into an aged care facility. In most cases people prefer to stay at home for as long as possible.

Online fee estimator — home care packages The online calculator (available at www.myagedcare.gov.au/fee-estimator) will help estimate the fees and payments that may be payable (for those who started receiving a home care package from 1 July 2014). The calculator provides estimates of the basic daily fee and income-tested fee. The actual fees payable will be assessed by Services Australia or DVA. Strategies to manage ITCF Because the ITCF is calculated based on income as determined under the social security rules, this effectively means that strategies which reduce income for social security purposes, would also reduce the ITCF (¶6-840). This could include investing in assets with a more favourable income test assessment, gifting within allowable limits, purchasing a funeral bond or pre-paying funeral expenses (to reduce financial assets upon which income is deemed).

INDEPENDENT LIVING ARRANGEMENTS ¶17-200 Independent living arrangements and retirement villages Another option when the family home is no longer appropriate may be to enter an independent living arrangement. There are three main types of independent living arrangements: • retirement villages

• supported residential services, and • independent living units. It is also possible for a person to separately be assessed and apply to receive home care services while living in one of these arrangements. It is important to note that these arrangements are not residential care, and therefore the fees and rules that apply are not determined in the same way as residential aged care. Each type of arrangement operates under its own specified government Act at either a state or federal level. Some facilities can have various types of arrangements within one facility and can be regulated at both state and federal levels. From an advice and strategy perspective, because these arrangements often come before residential care, it is important to consider the costs that may be associated with future aged care, to ensure it remains affordable — particularly after any “exit fees” or other transaction costs are taken into consideration.

¶17-210 Retirement villages Retirement villages provide housing for people aged 55 years and over, who are able to live independently. Retirement villages can provide an array of different support services, and these will vary from village to village. Some of the larger villages may even offer an “ageing in place” arrangement with an aged care facility on the premises as well. Retirement villages are not government subsidised, therefore, residents self-fund their accommodation. The resident does not own the unit, but rather purchases a loan licence agreement (lease). When the resident vacates the unit, it is sold at market value with the retirement village administration retaining a percentage of the sale value of the lease. Prospective residents need to be careful, and make sure they fully understand the way the refund is calculated, as well as other costs that may be deducted. Other fees include monthly maintenance fees, which typically cover the services provided by the village, and exclude telephone, electricity and contents insurance costs. It is critical to understand “exit fees” which may apply before entering in to an arrangement, particularly when it is likely that the client will need to fund aged care costs in a residential facility in the future. Because retirement villages are regulated by the states, contracts are not standardised. It may be important for a client to seek legal advice before entering into an agreement to ensure they understand all aspects of the contract prior to signing. It is important to note that the social security concessions that apply to aged care facilities will not apply to retirement villages. Therefore if an individual does not sell their home and moves into a retirement village, the home will be assessable as an asset for social security purposes and this can have a significant impact on an individual’s entitlement. The initial contribution paid will determine whether a person is classified as a homeowner or nonhomeowner. Rent assistance may apply if the person is assessed as a non-homeowner (see ¶17-240).

¶17-220 Supported Residential Services (SRS) Supported Residential Services (SRS) are usually privately operated or not-for-profit facilities designed to cater for older people who wish to live in a communal setting, and their health requires some support. This care can include assistance with showering, dressing, meals and medication, as well as physical and emotional support. Some SRS facilities also provide nursing or allied health services, however, no aged care assessment is required for entry. While the function of an SRS is similar to the previous “low level” care facilities, SRS facilities do not receive any government subsidies and the cost generally consists of a weekly or monthly fee which varies

greatly between facilities depending on the level of care provided. Bond payments are not required which can make this type of facility attractive for low care individuals who do not have access to large lump sums. However, it is important to note that the social security concessions that apply to aged care facilities will not apply to SRS facilities. Therefore if an individual does not sell the home and moves into an SRS facility, the home will be assessable as an asset for social security means testing, and this can have a significant impact on an individual’s entitlement.

¶17-230 Independent living units These types of facilities are usually self-contained units with small kitchen and own bathroom. The units are generally for older people or people with a disability who are able to live reasonably independently. The costs can vary significantly between facilities, however, many now require a sizeable ongoing contribution. The initial contribution paid will determine whether a person is classified as a homeowner or non-homeowner. Rent assistance may apply if the person is assessed as a non-homeowner. Generally, if an individual has paid an initial lump sum amount (entry contribution), the independent living units will be regarded as a retirement village under the Retirement Villages Act. The structure of the fees and costs are similar to that of retirement villages: • initial purchase price • monthly service fee • deferred management fee (DMF)/exit or departure fee.

⊠ Trap Financial care needs to be taken, particularly with deferred management fees which are payable upon departure from either a retirement village or independent living units. As these facilities are privately operated, the deferred management fee can be expensive. Residents need to be aware of the total cost prior to entry into a retirement village, SRS or independent living units, as failure to do so may impact on their capacity to pay for an aged care RAD for entry into an aged care facility if the need arises in the future.

¶17-240 Social security assessment and costs of retirement villages For social security purposes, the amount of the “entry contribution” (EC) determines whether the resident is assessed as a homeowner or non-homeowner. The entry contribution is the lump sum amount paid at the time of entry which is required in order to secure the room or unit. The entry contribution is assessed against a particular threshold (known as the “Extra Allowable Amount” or “EAA”) to determine: • whether or not the EC is an assessable asset for social security purposes, and • whether the individual is assessed as a homeowner or a non-homeowner. The EAA is the difference between the homeowner and non-homeowner social security asset thresholds. As at 1 July 2020, the EAA is $214,500. If

Is EC assessable under assets test?

Homeownership status

Rent assistance

EC > EAA

No

Homeowner

Is not payable

EC ≤ EAA

Yes

Non-homeowner

May be payable*

*Depending on the fees charged by the service provider.

Different rules apply to members of an illness separated couple where each member of the couple lives in a separate “special residence” (which includes a retirement village or granny flat arrangement). For more information, see Guide to Social Security Law: 4.6.4.10 General Provisions for Special Residences: guides.dss.gov.au/guide-social-security-law Social security assessment of former home If the former home has been sold, the proceeds are now classified as an assessable financial investment and the proceeds from the sale of the home will be subject to deeming. If the former home has been retained after a person moves into a retirement village, it is an assessable asset, and any rental income is assessable from the date the home is no longer the principal residence. The concessional treatment of the former family home which applies when a person moves into a residential care facility do not apply when a person leaves their former home to enter a retirement village. Example Rosemary’s family home is now too big for her to manage. She also wants to have more adult company as she feels very isolated in her family home despite home care services provided by the local council. Rosemary is still very active at 78 as she continues to drive her car. The independent living unit that she has chosen has a communal environment with all meals provided and additional care services Rosemary is adamant that she does not wish to move to an aged care facility and that she now wants as much care support available to enable her to stay where she is. The community she has chosen also provides palliative care.

Independent living unit costs Assets: Purchase price for lease (refunded on departure less costs and fees)

$650,000

Bank

$200,000

Car

$5,000

Contents

$5,000

Expenses: General service fees

$10,036 pa

All meals

$5,720 pa

Other expenses

$5,000 pa

Total ongoing expenses

$20,756 pa

Deferred management fee (deducted from refund of lease)

$195,000

Costs on exit for cleaning, painting and new carpets

$15,000

Income: Centrelink Age Pension

$24,551 pa

Interest earned on bank balance*

$6,000 pa

Total income

$30,551 pa

Surplus:

$9,795 pa

Calculations are based on rates and thresholds as at 1 July 2020. *Assumes interest earned at 3%

Rosemary is not left with a negative cash flow, particularly that her meals are also included. Her only other expense is the running of her car, clothes, gifts and outings. She still has $250,000 in the bank available to fund any expenses above her surplus. As her health deteriorates, she can increase her home care services and apply for the federally funded Consumer Directed Care (CDC) home care packages (HCP).

It is therefore important for your clients to ascertain the best value for money from the array of choices available in living arrangements for the over 50s. In Rosemary’s situation, she or her estate will have to pay an exit fee of $195,000, so this cost needs to be factored into the overall care savings if we were to compare this with the costs of federally subsidised aged care facilities.

RESIDENTIAL AGED CARE ¶17-300 Residential aged care facilities Aged care facilities provide various levels of supportive care and are administered and operated under the Aged Care Act 1997 (Cth). Aged care facilities are substantially funded by the federal government. In order for these facilities to receive residential care subsidies from the government, they must be accredited by the new Australian Aged Care Quality Agency. Facilities that are not government-funded do not have the same cost structure and are subject to different fees. Over the past few years, there has been significant legislative change in relation to aged care, which has impacted some of the fees and rules associated with these care arrangements. Summary of legislative changes Pre-1 July 2014

From 1 July 2014

High Care and Low Care

One level of care (merged)

Fee structure determined by level of care: – Bond (low level care) – Periodic Payment (high level care)

Same fee structure applies regardless of care needs: Lump sums referred to as: – “Refundable Accommodation Deposit” – “Refundable Accommodation Contribution” Ongoing daily payments referred to as: – “Daily Accommodation Payment” – “Daily Accommodation Contribution”

– Retention amount: facility could retain portion of bond paid

– Lump sum paid is fully refundable (unless resident chooses for certain other fees to be withheld from this amount)

– ITCF (capped daily) Means Tested Care Fee (annual and lifetime caps – Resident’s contribution to cost of care apply) determined by “income” as per social security rules Resident’s contribution to cost of care determined by “income” and “assets” as per social security rules (with exceptions). Pre 1 July 2014 entry to care The new legislation is only applicable to residents who entered aged care for the first time since 1 July 2014. Existing residents who entered permanent care before 1 July 2014 will not have their aged care fees adjusted to meet the new fees and charges. The only exceptions are as follows: • Residents who entered permanent care before 1 July 2014 who later transfer to a new aged care service after 1 July 2014 and who choose to be assessed under the new rules. • Residents who entered care before 1 July 2014 and then subsequently have been discharged from aged care for more than 28 continuous days (other than approved leave) and then decide to re-enter aged care after 1 July 2014.

¶17-310 Residential care and the entry process The process for entering care generally includes:

• an ACAT Assessment • calculating fees, and • entering care.

¶17-320 ACAT assessment Before an individual can enter aged care, they will generally need to be assessed by the Aged Care Assessment Team (ACAT) or the Aged Care Assessment Service (ACAS) if in Victoria. Residential care facilities provide what was traditionally referred to as “low level” and “high level” care that was previously provided in “hostels” or “nursing homes”. The merging of the aged care levels means that there is one fee structure in place and this will not change as an individual’s health and care needs increase. Families therefore do not need to worry that aged care fees will change for the duration that a loved one is a resident in an aged care facility. On this basis the new reforms have made placement into aged care somewhat easier. Once the assessment has been completed, ACAT will notify the applicant as to what level of care they qualify for. The assessment may indicate that the person in eligible for a home care package (¶17-120), respite care in an aged care facility, of permanent residential care. During the assessment questions will be asked to ascertain what types of support the person already receives, health and lifestyle questions, whether the person has health concerns, and issues relating to the home and personal safety. If the person is assessed as having a need for residential care, the assessment is generally valid indefinitely. A website has been established by the government, called My Aged Care www.myagedcare.gov.au. The phone number is 1800 200 422. The My Aged Care team can help to locate the nearest ACAT to initiate an assessment.

¶17-330 Entering care Moving into a care facility is a highly emotional, and often confusing experience. Below is a checklist which summarises some of the important points and actions required which relate to when a person enters full time, permanent care: ☑ Accommodation Agreement – must be issued by the facility prior to entry ☑ Decide how Accommodation fees will be paid (lump sum/daily ongoing?) ☑ Sign and return Accommodation Agreement within 28 days of entry ☑ Resident cannot be required to elect how they will pay their fees prior to this 28 days period ☑ Lodge the appropriate form to have the means-tested fee determined ☑ Notify Services Australia of change in circumstances once entry to care occurs Members of a couple entering care and social security Rate of payment Where one member of a couple enters care, they will be regarded as “illness separated” for social security purposes. This means that: • entitlement is still determined with consideration of the pooled income and assets of the couple, • any reduction in entitlement is deducted from the single rate of entitlement (each), and

• different cut-out thresholds apply when determining entitlement under the income and assets test, and under the income test that applies to the Commonwealth Seniors Health Card. This means that members of a couple will generally see an increase in their entitlement. Members of a couple will be treated as illness separated even where both are in residential care, or even when they are in the same room of a residential care facility. Centrelink/DVA will need to be notified of a person’s entry to care in order to effect this change. Assessment of certain assets Any lump sum RAD or RAC paid by a person is exempt for social security means testing (it is not, however, an exempt asset when calculating the means tested fee). For members of a couple this may lead to an additional increase in entitlement when assessable assets (such as money in a bank account) are used to pay a lump sum care cost. The way in which a homeowner’s former family home is assessed for social security purposes will depend on a couple of factors, including its ongoing use. See ¶17-350 for a detailed discussion about aged care and the family home.

¶17-340 Calculating aged care costs When a person enters a government subsidised aged care facility, there are a number of fees that they may be asked to pay. It may help to think about it from this perspective — some fees cover the cost of the room and accommodation facilities, and others cover the ongoing cost of care (for example, food and services). 1. Basic daily care fee

The basic daily care fee (or “standard resident contribution”) is generally payable by all residents, for each day that they are in care. It is a contribution towards the costs of daily living such as care, meals, laundry, cleaning and heating. The fee is calculated at 85% of the full single Age Pension. As at 1 July 2020, the basic daily fee was $52.25. This is the rate regardless of what amount of Age Pension a resident actually receives. That is, a part-Age Pensioner or a person with no Age Pension entitlement at all will still pay the basic daily care fee (unless the hardship provisions apply – see (¶17-380)). As the Age Pension is subject to indexation on 20 March and 20 September each year, this means that the basic daily fee will also increase accordingly for both new and existing residents. 2. Means tested care fee

The means tested care fee (MTF) replaced the former ITCF and now encompasses both a person’s income as well as their assets. The intention behind this change was that individuals with the means to pay be required to contribute towards the cost of their care.

A formula applies to determine a resident’s means tested fee. Who calculates the fee and when? The MTF is determined based upon a resident’s income and assets at a time, and is: • calculated at the time of entry, • re-calculated quarterly, and • is reassessed where there is a significant change in circumstances (in which case the person will need to notify Services Australia or DVA). This means that as a resident’s level of assessable assets and income fluctuate whilst they are in care, so too will their MTF. Annual and lifetime caps apply to the MTF (see below). Change of circumstances and the MTF If a person is already in aged care and their financial circumstances change, such as the former home has been sold, or their spouse moves out of the family home (for example), the resident should also advise Services Australia or DVA. Reassessment of the MTF is completed automatically on a quarterly basis. This delay in the change in the means tested fee may create some angst with clients, particularly if cash flow is tight, and the change in the fee is not anticipated. Where a resident is found to have overpaid MTF for the previous quarter, the overpayment will be refunded. A person will not be forced to backpay fees however, if they have been undercharged MTF based on their assets and income at the time of the next quarterly review. Assessment of the MTF A new process was recently implemented in relation to the assessment of the MTF. Depending on a person’s circumstances, they may: • Lodge a ‘Residential Aged Care – Calculation of your Cost of Care’ form (SA457). This form can be used by individuals who do not get a means-tested payment from Centrelink, and own their own home. • Lodge a ‘Residential Aged Care- Property details for Centrelink and DVA customers’ form (SA485). This form can be submitted by individual’s entering care who do receive an income support payment, and who have a family home. • Lodge an ‘Aged Care calculation of your Cost of Care’ form (SA486). This form is a dynamic pdf form which needs to be completed online. The form is tailored to an individual’s circumstances based on the responses provided to the questions asked. Upon completion, the form needs to be printed, signed and returned to Services Australia. • Have Services Australia automatically calculate the MTF, if they receive an income support payment and do not own their own home.

☑ Tip The forms can be completed and sent directly back to Services Australia without any requirement to disclose a client’s means to the facility. A facility may however have their own application form, and may request an indication of a person’s means. While the person cannot be required to disclose this information, the facility may be requesting an indication of means to ensure that the person is placed in the correct room, based on whether or not they are a “supported/partially supported resident” (see “Accommodation Payment”).

An SA457 assessment is valid for 120 days. This means that it may be possible to have an assessment in advance of moving into care. If there is a change in the resident’s circumstances after the fee advice has been issued and before the person has entered care, a new assessment should be completed and lodged (as well as notifying Services Australia or DVA of the change in financial circumstance) and a new fee notification will be issued.

☑ Tip It is not compulsory to provide financial details to Services Australia to have the MTF calculated, however, residents may pay a much higher daily MTF if it is not completed. In this case, residents will pay the actual cost of their daily care. The annual and lifetime caps still apply to residents who do not disclose their means. A common question is whether there is any benefit to completing an assessment in the case of a resident who would hit the annual MTF cap based on their income and assets. One of the considerations in this case is that non-disclosure might provide an outcome where the resident pays a much higher amount on a daily basis, for a shorter period of the year, hitting their annual cap sooner. In the event that the resident passes away, there is no rebalancing or refund of any amounts paid.

Annual and lifetime caps The MTF is the only residential care fee that is subject to annual and lifetime caps. The caps are indexed periodically. A person who is liable for the MTF will pay this fee for each day they are in care for the year, until they reach the annual cap. As at 1 July 2020, the annual cap was $28,087.41. A year for this purpose runs from the date of entry, through to the anniversary date on an ongoing basis. Once the annual cap is reached, the person will not have an obligation to pay any MTF until their next anniversary date. If the annual cap is indexed part way through the year, the annual cap that applies to that person for that year would be the annual cap which applied at the date of entry to care (or as at their last anniversary date for subsequent years of residency). A lifetime cap also applies to the MTF. As at 1 July 2020, the annual cap was $67,409.85. Once the lifetime cap is reached, the person is no longer liable to pay the MTF. For current rates, see ¶20-580. Both caps operate on a per person basis. This means if a person transfers from one facility to another, their cap comes with them. The caps only apply to the MTF. Once the annual or lifetime cap is reached, other fees will continue to be payable.

☑ Tip Any income tested fees that a person has paid in respect of a previous home care package will also count towards the residential MTF caps.

Example Leon enters an aged care facility on 1 August 2020. His means tested fee is calculated by Centrelink to be $82 per day. The annual cap on the day Leon entered care was $28,087.41. Leon will pay $82 per day (assuming his MTF remains unchanged) for approximately 343 days. At this point, he will hit the annual means tested fee cap. The government will cover the cost of Leon’s care for the duration of that year. Leon will need to continue paying the basic daily fee, accommodation payment, and extra services fee (if applicable). On 1 August 2021 (anniversary date of entry), Leon would recommence paying a means tested fee again.

How the fee is calculated A person’s MTF at a time is determined based on: • an assets tested component • an income tested component, and • the prevailing Maximum Accommodation Supplement All residents who are ACAT assessed and also have their means assessed are eligible for government support with the MTF. This is a supplement which is paid to the facility. If this form is not completed the resident will need to pay the full cost of their care. There are two important steps when calculating the MTF. The first step is to determine what is known as the “means tested amount” (MTA). Once the MTA is known, it is reduced by the prevailing Maximum Accommodation Supplement, and the resulting amount is the person’s MTF. Means-tested fee calculation  Income tested component + Assets tested component = Means tested AMOUNT (MTA)*    MTA – Maximum Accommodation Supplement = Means tested FEE (MTF) 

☑ Tip The MTA is an important calculation. It is also used to determine a person’s accommodation fee, and whether or not the person is eligible for further government assistance with this cost (that is, whether or not the person is partially or fully government supported).

An individual’s assessable income pool and assets pool (for this purpose) is generally calculated in accordance with the social security rules that are used for Age Pension means testing purposes (regardless of whether the care receiver receives any government support). Broadly, valuation of assets and income for MTF purposes is as per the Social Security Act, with several key exceptions (where social security and aged care rules differ). 1) Income tested component Income for this purpose includes all income assessed for income support purposes, plus any income support payments received by the person, less the Minimum Pension Supplement and Energy Supplement. Certain disability benefits paid from DVA, and War Widows pension (where there is qualifying service) are not assessed as income for the MTF. In respect to members of a couple, the total couple income is pooled, and each person is assessed against 50% of the combined income. Once the assessable income pool is determined, it is reduced by the applicable income free area, and only 50% of income about the threshold is used to calculate the income tested component of the MTF. Income-tested component =  Total income – income-free area x 50% ÷ 364* 

*The amount is divided by 364 to reduce it to a daily amount. This denominator is used to produce an outcome that provides 26 equal fortnightly periods.

As at 1 July 2020, the applicable income free areas are:

• $27,840.80 (single person) • $27,320.80 (illness-separated couple, per person). 2) Assets-tested component The assets-tested component of the MTF broadly captures all assets as they are assessed for income support purposes, with several key exceptions: Asset

Social security assessment

MTF assessment

Lump sum accommodation payment or contribution (RAD/RAC)

Exempt

Fully assessed as an asset (no deemed income)

Family home (see “Assessment of the home” section for a more detailed explanation)

Exempt asset for 2 years from date of entry  Exempt indefinitely only while spouse remains in home 

Immediately assessed up to the “home cap” unless occupied by a “protected person”

After the total asset pool is determined (remember, in relation to members of a couple, total assets are pooled regardless of legal ownership, and each person is attributed with 50% of the asset value), the asset pool is applied against an asset free area ($50,500 as at 1 July 2020), and two additional asset thresholds to calculate the assets tested component. Asset tested amount =  17.5% of difference between asset free area and 1st threshold, plus    1% of difference between 1st and 2nd threshold, plus    2% of excess above 2nd threshold, then    Divided asset tested amount by 364*.  *The amount is divided by 364 to reduce it to a daily amount. This denominator is used to produce an outcome that provides 26 equal fortnightly periods.

Based on the prevailing asset thresholds as at 1 July 2020, the assets tested component is equal to: • 17.5% x assets $50,500 - $171,535.20+ • 2% x assets $171,535.20 - $413,605.60+ • 1% x assets above $413,605.60. Example — residential aged care: MTF Tony is 85 and is to enter an aged care facility as a permanent resident. He has selected a room with a RAD of $200,000 but will pay this entire amount as an ongoing daily payment (see “Accommodation payment”). His financial position is summarised below, including the assessment of each for MTF purposes: Assessment for assets tested component

Assessment for income tested component

Former family home — valued at Capped value $750,000 $171,535.20

Nil

Home contents

$10,000

Nil

Car

$7,500

Nil

Shares

$10,000

(Deemed income)

Account-based pension – Account value $200,000

$200,000

(Deemed income)

Net rental income – family home (annual)

Nil

$10,000

Cash account

$75,000

(Deemed income)

Age Pension (as at 1 July 2020)

Nil

$17,850.50 (Age Pension less Minimum Supplement and Energy Supplement)

Total

$474,035.20

$33,203 (includes $5,352.50 of deemed income)

(not grandfathered — see ¶6840)

The income tested amount Total assessable income

$33,203

Income-free area

$27,840.80

Total assessable income is greater than the income-free area by

$5,362.20 ($33,203 $27,840.80)

The income tested amount is 50% of the excess income amount /364

$7.36 daily (50% × $5,362.20/364)

* Calculations are based on rates thresholds as at 1 July 2020.

The assets tested amount If asset tested amount=  17.5% of difference between asset free area and 1st threshold, plus    1% of difference between 1st and 2nd threshold, plus    2% of excess above 2nd threshold, then    Divided asset tested amount by 364.  Tony’s assessable assets for the MTF are $470,851.20. Based on the prevailing asset thresholds as at 1 July 2020, Tony’s assets tested component is equal to: • 17.5% x assets $50,500 - $171,535.20+ • 2% x assets $171,535.20 - $413,605.60+ • 1% x assets above $413,605.60. = ($21,181.16 + $4,841.41 + $604.30)/364 = $73.15 Therefore: Income tested component + assets tested component = MTA $7.36 + $73.15=$80.51 MTA – Maximum Accommodation Supplement = MTF $80.12 – $58.19 = $22.32 This means that Tony will pay: • a basic daily fee of $52.25 pd • a MTF of $22.32 pd, and

• a daily accommodation payment of $22.47 pd (see below). 3. Accommodation payment

Most people entering aged care will be liable to pay an accommodation payment or accommodation contribution. The fee (or contribution) can either be paid as: • a refundable lump sum, • an ongoing daily payment (non-refundable), or • any combination of both. Any lump sum a person is liable for which is unpaid, must instead be paid as a non-refundable daily payment. This means that a person can effectively accept a bed at a facility where the lump sum cost of the room is greater than their net assets. The resident has full discretion as to how much of the fee to pay as a daily payment verses as lump sum. The only exception to this is that after payment of an initial lump sum accommodation fee, the person must be left with a minimum level of assets. This minimum asset threshold was $50,500 as at 1 July 2020. Any amount that the person is unable to pay as a lump sum due to the minimum asset requirement, must be made up as an additional daily payment. Determining the accommodation payment There are three “levels” a person can fit into at the time of entry to care, which are based on the person’s MTA (see “Means-tested fee” above). The level in which a person fits determines whether or not they will need to pay an accommodation fee, and the amount that they will be liable to pay. Effectively, it is the MTA which determines whether the person is eligible for any government support with this fee.

Level 1: Self Supported

A person who is self-supported will be liable to pay the “published rate” of Accommodation Payment. Each individual facility will set this fee based on the room. Regardless of any future change to the person’s MTA (as assets and income levels fluctuate), if a person is assessed as self-supported at entry, they will not be eligible for government assistance with this fee at a future time (unless they enter into a subsequent accommodation agreement in the future and their means have reduced). An accommodation payment can be paid as either a “Refundable Accommodation Deposit” (RAD) or a “Daily Accommodation Payment” (DAP). This fee is set by the aged care facility for a specific room. A resident can choose whether they pay this fee as a lump sum, daily payment, or any combination of the two. A resident will have 28 days after entering an aged care home to nominate how they wish to pay their fee. Refundable Accommodation Deposit “RAD”

• fully refundable upon exit (unless resident has agreed to have other fees and charges deducted from the RAD paid) • capital guaranteed by government • 6 months after entry to pay (pay DAC in interim) • facility can charge up to $550,000 before government approval required • cannot “overpay” RAD • RAD prices must be advertised on myagedcare.gov.au • RAD is assessed as an asset (not deemed) to calculate MTF • RAD is an exempt asset for social security purposes • if resident requests DAP to be drawn from RAD facility must agree. Optional for facility to agree to other fees and charges being deducted. Additional daily payment may become payable. • refunded to estate when resident passes away

Daily Accommodation Payment “DAP”

• effectively interest on any RAD which is unpaid • not refundable • calculated based on prevailing “Maximum Permissible Interest Rate” (MPIR) at date of entry (4.10% as at 1 July 2020) • DAP will be payable until chosen amount of RAD is paid to facility

The DAP can be calculated based on the unpaid RAD amount by using the below formula: DAP= RAD x MPIR / 365

Example Remember Tony from our MTF example? Tony accepted a bed at a facility with a RAD of $200,000. Tony does not want to sell his family home, and wishes to save the relatively small amount of money he has saved to cover the cost of his funeral, as well as to pay ongoing medical expenses. Tony’s DAP can be worked out as follows. $200,000 × 4.10%/365 = $22.47 per day (DAP) This means that Tony’s total aged care fees will be: • the basic daily fee of $52.25 pd (subject to indexation) • a MTF of $22.32 pd (may change as Tony’s means change), and • a DAP of $22.47 pd. Even though the MPIR may change after Tony enters care, his DAP will be fixed based on the MPIR at entry.

Calculations are based on thresholds as at 1 July 2020.

Example Ken accepts a bed in his local aged care facility on 4 July 2020. Ken is a self-supported resident based on his MTA at entry. The room he accepts has a published rate of RAD of $400,000. Ken pays $100,000 to the facility as a RAD. The unpaid $300,000 is converted to a DAP as follows: $300,000 × 4.10% / 365 = $33.70 per day (DAP) This means that in addition to the basic daily fee, MTF, and RAD of $100,000, he is also liable to pay a DAP of $33.70 per day. Even though the MPIR may change after Ken enters care, his DAP for this care arrangement will be fixed based on the MPIR at entry. Calculations are based on thresholds as at 1 July 2020.

☑ Tip A common misconception is that if the person has a family home, the home will need to be sold to pay the lump sum payment. This is incorrect. A person cannot be compelled to sell their family home, and provided their cash flow is adequate, the person could choose to pay their entire accommodation fee as a non-refundable daily payment. A person who has sufficient liquid assets however may wish to carefully consider whether or not to leave funds invested, or whether to pay off some or all of the RAD. Because the effective after rate return on a RAD paid is equal to the MPIR (4.10% as at 1 July 2020) it can often be quite compelling to direct resources to making a RAD payment. In addition, Centrelink/DVA entitlements may increase as a RAD is an exempt asset.

Level 2 and 3: Supported and partially supported A Level 2 resident is considered to be partially supported. This means that they are eligible for some government assistance with their accommodation fee. A Level 3 resident is fully supported, and the government will pay the full cost of their accommodation. Similar to a Level 1 individual, a partially supported (Level 2) resident can choose how much of their accommodation contribution to pay as a lump sum or daily amount. The terminology used for fees payable by a partially supported resident is either a “Refundable Accommodation Contribution” (RAC) or a “Daily Accommodation Contribution” (DAC). As per the rules that relate to the payment of an initial lump sum, the person must be left with a minimum level of assets ($50,500 as at 1 July 2020). Any remaining contribution payable would need to be paid as a DAC. Where a person is a Level 2 or 3 resident at entry, their ongoing DAC at a time is equal to their MTA (this is why the MTA is an important calculation — that is, even if a person does not have a MTF we still need to know their MTA to determine their accommodation fees). Because the MTA is recalculated periodically and is based on income and assets at the time of calculation, this means that a person who is fully supported at entry (and therefore has no liability at that time to pay any accommodation fee — that is, their MTA = 0) may actually be required to pay a RAC/DAC sometime after entry if their MTA > 0. Similarly, a person who is partially supported at entry (ie Level 2) may have their accommodation contribution recalculated after entry if their MTA changes. A Level 2 or 3 person cannot be reassessed as a Level 1 resident in respect of that care arrangement. That is, they cannot be required to pay the “published rate” or RAD/DAP. The maximum DAC they can ever be required to pay is capped at the prevailing Maximum Accommodation Supplement at a time. To determine the applicable RAC based on the person’s DAC (which is the MTA): MTA = DAC RAC = DAC x 365 ÷ MPIR*

 *Based on MPIR at entry 

Example Warren accepts a bed in his local aged care facility on 31 August 2018. At the time of entry, Warren’s MTA is $40.00. Because the MTA is > 0 but less than the Maximum Accommodation Supplement on this day ($58.19) Warren is a “Level 2” resident (partially supported). In this case, his “DAC” is equal to his MTA. That is, the DAC = $40.00 pd. If Warren wanted to pay his Accommodation Contribution as a RAC, the DAC could be converted as follows: $40.00 x 365 / 4.10% = $356,097.56 Calculations are based on thresholds as at 1 July 2020. If Warren decided to pay $150,000 as a RAC, the additional DAC could be determined as follows: Unpaid RAC = $356,097.56 – $150,000 = $206,097.56 $206,097.56 x 4.10% / 365 = $23.15 pd Warren would need to pay the RAC and/or DAC in addition to the basic daily fee. Even though the MPIR may change after Warren enters care, when calculating his accommodation fee, the MPIR as at the date of entry to care will always be used. Although Warren does not have to pay a MTF now, if his financial circumstances change in the future, he may be required to commence paying a MTF. Also, the maximum amount of DAC he could ever be asked to pay will be equal to the prevailing Maximum Accommodation Supplement. Based on the rates at 1 July 2020, the maximum DAC would be $58.19 pd and the maximum RAC would be $518,032.93.

4. Extra service fees or additional service fees

Aged care legislation requires that the same level of basic care be afforded to all residents. The extra service fee does not mean that the resident will receive a higher quality of care, but relates to the types of facilities and services that will be accessible. For example, this may include a broader variety of meal options, telephone services, and pay TV. The new legislative changes allow extra service fees to be optional. However, in reality facilities have not provided this opt in opt out service. So facilities that have extra service fees will require that these payments are compulsory. These fees can be financially prohibitive, however residents can request for this fee to be drawn down from the RAD, if a RAD payment has been made. This can then provide cash flow relief and allow the capital in the bank to be utilised for other expenses, if there is a deficit after expenses. Online fee estimator — residential care An online calculator can be accessed via the MyGov website at myagedcare.gov.au. The calculator will help estimate the fees and payments that may be payable (for those who entered from 1 July 2014). The calculator provides estimates of the basic daily fee, MTF, and accommodation contribution (if applicable). The actual fees payable will be assessed by the Department of Human Services.

¶17-350 The family home and aged care Arguably one of the biggest and often most emotional decisions a person will need to make when they enter aged care is in relation to what to do with the family home. Often there is a desire to retain the home in the bloodline. Other times, it is simply because moving into care is already such an emotional time, and making such a big decision is often unbearable.

For members of a couple, this may not be an immediate consideration if one member of the couple stays on in the family home. However it is important not to disregard a conversation about the future accommodation needs of the spouse remaining in the family home, as this could have a significant impact on both members of the couple in future, from a social security, aged care, and estate planning perspective. There is a very different assessment of the family home applied for aged care fee purposes, when compared to the assessment that applies for social security payment purposes. Previously, concessional treatment was afforded to certain aged care residents when their family home was retained and rented, and they were liable to pay a daily payment in respect of their accommodation fees (that is, they hadn’t paid the RAD/RAC, or “bond” in pre 1 July 2014 terminology, in full). However, these concessions are no longer available for most individuals entering a care arrangement today. Assessment of the home for social security purposes When a person moves into a residential aged care facility, their family home remains exempt under the assets test for two years. During this time the person is assessed as a homeowner. At the end of this twoyear period, the full value of the home is assessed under the assets test and the person will be assessed as a non-homeowner. In the case of members of a couple, the home is exempt indefinitely while one member of a couple continues to live in the home. In the event that this person either passes away, or also moves out of the home and into care at a later stage, this two-year period will commence for both individuals at the time the second member of the couple departs the home. There will be an assessment under the income test where the family home is rented. In this case, the rental income (less allowable deductions for social security purposes) will be assessed as income. If a resident first entered care before 1 January 2017 (and has not subsequently left care after this date for a period of more than 28 consecutive days, other than approved leave), the family home will remain an exempt asset so long as: • the home is rented, and • the person is paying or accruing a liability to pay a DAP/DAC (or a periodic payment, if the person entered care pre 1 July 2014). It is important that Centrelink/DVA are notified within 14 days of any change of circumstances.

☑ Advice tip It is important when providing initial aged care advice to consider what the client might do with the home in the longer term. This can have a significant impact on the appropriateness and sustainability of the initial recommendation — particularly where social security income is the primary source of cash flow. If the client was to lose entitlement to social security benefits at a future point (for example, after two years in care where the full value of the home is assessed under the assets test, which may lead to a loss of Age Pension entitlement under the assets test). Consideration should therefore be given as to the sustainability of the recommendation.

Below is a summary of some common scenarios in relation to the family home, where one member of a couple enters care. The table summarises the social security assessment in each scenario. If spouse remaining in home …

Assessment of home — social security

Continues to remain in the home

Exempt for means testing

Subsequently leaves home to enter care 2-year exemption applies under the assets test to both

members of couple. Exemption commences from the date of the second spouse’s entry to care Temporarily leaves the home other than for care/illness related purposes

The “temporary vacation” rules that allow for a maximum 12month home exemption applies from later spouse’s departure. Exemption is concurrently applied with the general 2-year exemption commencing from date of the first spouse’s entry to care. Exemption will generally cease to apply at the later of: – 2 years from the first spouse’s date of entry to care, or – 12 months from second spouse’s date of temporary departure.

Sells the home — intention to purchase/build a new home generally within 12 months

– Homeowner status continues – Proceeds of sale which spouse intends to use to purchase/build new primary residence are exempt from the assets test for up to 12 months (up to 24 months in certain circumstances). – Full proceeds deemed immediately upon sale (if for example invested in a bank account).

Subsequently passes away

2-year exemption will apply to spouse in aged care commencing from date of spouse’s death. After this time the home is fully assessed under the assets test and the person is a non-homeowner.

Assessment of the home for aged care purposes The family home may have an impact on both the accommodation payment, as well as the client’s MTF. Summary of assessment:

Assessment for means tested fee The full value of the family home will be exempt where the person’s spouse, or a “protected person” remains in the home. A protected person is an individual who is entitled to an “income support payment” and is: • a carer, who has resided in the home for a period of at least two continuous years immediately prior to the person’s entry to care, or • a close relative* who has resided in the home for a period of at least five continuous years immediately prior to the person’s entry to care. *A close relative for this purpose is generally defined as a parent, sibling, child or grandchild of the person.

Note An “income support payment” includes Age Pension, Disability Support Pension, JobSeeker and Carers Payment. It does not include Carers Allowance. The only requirement is that the person is eligible for the payment – they need not actually be in receipt of the payment.

If the home is rented or vacant, the value of the home will be assessed when determining the assets tested component of the MTF, up to a “home cap”. This cap is the maximum value that will be assessed. As at 1 July 2020, the home cap was $171,535.20 (subject to indexation). For members of a couple, the cap applies per person. If the market value of the home is less than the prevailing home cap, then the actual value will be assessed. Where the home is rented, rental income (less allowable deductions for social security purposes) will be assessed as income for the income tested component of the MTF. Residents who entered care before 1 January 2016 (and have not subsequently left care after this date, for a period of more than 28 consecutive days, other than approved leave), are eligible for an exemption on rental income received from the family home so long as: • the home is rented, and • the person is paying or accruing a liability to pay a DAP/DAC. No assets test exemption applies, and the home would still be valued at up to the home cap.

☑ Tip Because the MTF is re-assessed quarterly (or as circumstances change), it is important to consider the implications of any change in circumstances in respect of the home on the MTF. For example, if a person’s spouse remains in the home initially, but subsequently enters care and sells the home or leaves it unoccupied, this will trigger a re-assessment of the MTF (because the home will now be valued at either up to the cap if retained, or full sale proceeds may be assessed if sold).

Assessment for accommodation payment Whether a person is eligible for any government assistance with their accommodation fee (that is, the person in either partially or fully supported) is determined by the means tested amount (MTA) at entry. The maximum RAD or RAC a person can pay is also limited by their assessable assets. After payment of an initial RAD or RAC, the person must be left with a minimum level of assets. This amount is currently $50,500 (as at 1 July 2020). When determining the person’s assets, the full value of the home is assessed, unless occupied by a spouse or protected person (in which case the assessable asset value is zero). That is, the home cap does not apply for this purpose.

¶17-360 Changing aged care facilities When a person voluntarily changes aged care arrangements, be it a new room in the same facility, or moving to an entirely new facility altogether, a new accommodation agreement will need to be entered into. This will involve a re-assessment of fees. Depending on the person’s financial circumstances at that later time, this may mean the person’s eligibility for partial or full government support (in relation to the

accommodation fee) will change. It is possible for a person to enter into an arrangement which is more expensive compared to the prior arrangement. If changing facilities, any RAD or RAC paid will be refunded upon departure (less any fees that the resident has elected to have withheld periodically from the lump sum paid). The resident will then be responsible for making any lump sum RAD/RAC payment in respect of the new care arrangement to the provider.

Note Residents who entered care pre 1 July 2014 cannot be required to “top up” a bond when transitioning between care arrangements. The bond paid to their original facility can simply be rolled over to the subsequent provider. This is provided there is not a break in care that exceeds 28 days (unless on approved leave). It is also possible to “opt-in” to the new fee arrangements at this time, if advantageous. In this case, the person may need to pay the full published rate of RAD/DAP.

¶17-370 Respite care Respite care provides a person with the ability to receive high level care on a temporary basis, either through community based providers, or via a short term stay at an aged care facility. This type of care is effectively designed to provide carers (who are often family members) with a reprieve from the significant responsibility of providing full time care to a loved one. Respite care may be appropriate where for example: • a more mobile spouse who has been caring for their partner needs to, for example, go into hospital for a minor operation, or • where a close family member who has been caring for the person needs to travel. Respite may be provided: • in a residential care facility • in the person’s own home • as centre-based day or short term respite, or • in the home of a “host-family”. Assessment for respite care Assessment for residential respite care is completed by ACAT. An individual may access up to 63 days of residential respite each financial year (may be extended in blocks of 21 days in certain circumstances). To access community based respite care, an assessment will need to be completed by the RAS. Individual facilities may need to be contacted to confirm the availability of a respite position at a given time. It may be hard to “book” a respite position at a residential a significant period of time in advance, due to the difficulty in being able to predict vacancies at a specific time. Cost of respite care The fees and charges associated with respite care may differ, depending on the types of care and services required. Individuals receiving residential based respite care will be required to pay a basic daily fee. A booking fee

may also be payable however this is a pre-payment of fees (to a limit), and not an additional charge. Financial hardship assistance may be available in certain circumstances (see ¶17-380).

¶17-380 Financial hardship assistance for aged care Financial hardship assistance is available for aged care fees (this is separate from Centrelink’s hardship provisions). Discounts may be provided for daily fees and accommodation payments as follows: • basic daily care fee • means tested care fee • daily accommodation contribution • daily accommodation payment. Residents who have difficulty in paying their aged care payments can apply for financial hardship assistance by filling out a “Financial hardship assistance for Residential Aged Care” form (SA461) and submitting it to Services Australia. Each case is considered on an individual basis, however there are guidelines is place such that financial hardship assistance is generally only granted where the person: • has not gifted in excess of the allowable thresholds ($10,000 per year up to a maximum of $30,000 in the previous five years) • does not have assets that can be sold or borrowed against that exceed a set threshold ($36,827.70 from 1 July 2020), and • has supplied their financial details and has completed an assessment via Centrelink (or DVA if applicable) for the assessment of the MTF. If a person has assets exceeding the threshold it may be possible to apply to have these assets assessed as being “unrealisable”. Unrealisable assets might include jointly owned property, a house that remains unsold after being on the market for at least six months and frozen assets. Investment properties and interests in private trusts and companies are usually excluded. It is also possible to apply under the hardship provisions where the person is receiving home care services or respite care in a residential care facility (the “Financial hardship assistance for Home Care and Residential Respite Care” form (SA462) would need to be filled out in this instance). Once a completed application (together will all supporting documentation has been submitted) a decision will generally be communicated to the resident in writing within 28 days.

FINANCIAL AND ESTATE PLANNING ON FAMILY BREAKDOWN The big picture

¶18-000

Introduction to financial planning on family breakdown

¶18-005

The Family Court

¶18-010

What about de facto relationships?

¶18-015

Estate and financial planning: Is it necessary?

¶18-020

Property settlement The four-step approach to property settlement

¶18-100

Property settlement step 1: Identification of the property pool

¶18-105

Property settlement step 2: Assessment of contributions

¶18-110

Property settlement step 3: s 75(2) ‘‘Future needs’’

¶18-115

Property settlement step 4: Justice and equity

¶18-120

Superannuation and family breakdown Superannuation splitting

¶18-200

Binding death nominations and superannuation splitting

¶18-205

Taxation and family breakdown Realisation and taxation costs to be taken into account in property valuations ¶18-300 Are tax losses property?

¶18-305

Superannuation concessions and taxation

¶18-400

Trusts and family breakdown

¶18-450

Investment properties and family breakdown

¶18-500

CGT rollover relief on family breakdown

¶18-505

Deemed dividends and company loans

¶18-510

Part IVA considerations when advising on family breakdown

¶18-515

Stamp duty and family breakdown Stamp duty exemptions on marriage or relationship breakdown

¶18-600

Principal place of residence

¶18-605

Land tax and family breakdown Land tax and family breakdown

¶18-610

Family trust elections Income and taxation opportunities in making a family trust election

¶18-615

Income splitting during marriage or relationships and after separation

¶18-620

Indemnities and guarantees from the controlling spouse

¶18-625

Maintenance Spouse maintenance

¶18-700

Child maintenance and support

¶18-705

Adult child maintenance

¶18-710

Child maintenance trusts

¶18-715

Other issues Full and frank disclosure of financial position

¶18-800

Issuing or receiving a subpoena

¶18-805

Family Court’s powers over business entities

¶18-810

Third parties standing in the Family Court

¶18-815

When one of the spouses is bankrupt

¶18-820

Binding financial agreements

¶18-825

Estate planning for blended families

¶18-830

Alternate Dispute Resolution

¶18-835

¶18-000 Financial and estate planning on family breakdown

The big picture Think outside the box: There are significant financial planning, estate planning and taxation issues and opportunities that financial advisers (and family lawyers) should be aware of and address on marriage or relationship breakdown for their clients. ¶18-005 The Family Court: The Family Law Act 1975 confers wide powers upon the Family Court in relation to property and financial resources of separated spouses. This includes de facto couples and samesex couples. ¶18-010 Estate planning — is it necessary?: One of the greatest areas where negligence claims could be levelled against professional advisers (including financial advisers and lawyers) relate to lack of advice on estate and financial planning matters prior to, or on marriage breakdown. ¶18-020 The four-step approach: Up until the High Court decision in Stanford (2012), the Family Court’s approach to property settlement was enshrined in a methodical four-step approach. Has the four-step approach been turned on its head? ¶18-100 The four-step approach the court undertakes is as follows: (1) identify the pool of property (including superannuation and tax liabilities) ¶18-105 (2) assess contributions that each of the parties have made to the accumulation of the pool ¶18110 (3) assess the s 75(2) factors — commonly known as “future needs factors” ¶18-115 (4) examine whether or not the result will deliver justice and equity between the parties ¶18-120. Superannuation splitting: Superannuation splitting has been available since 2002, and from 1 March 2009, was also extended to de facto separated couples. The court still has discretion as to whether to split super or not. There are also opportunities in enlarging the property pool by doing a super split. ¶18-200

Taxation issues: There are significant taxation issues and opportunities to take into account in any property settlement. These include: • Realisation and taxation costs ¶18-300 • Taxation losses ¶18-305 • CGT on supersplitting ¶18-400 • CGT on transfer of property ¶18-500 • Deemed dividends and company loans ¶18-510 • Tax avoidance ¶18-515. Stamp duty exemptions on marriage or relationship breakdown: There are exemptions from duty following breakdown of a marriage or de facto relationship. ¶18-600 Land tax: In NSW, land tax is a tax levied on the owners of land situated in NSW as at midnight on 31 December of each year. There is no land tax rollover relief on marriage or relationship breakdown. ¶18-610 Income and taxation opportunities: During the duration of a marriage or relationship, parties generally split the income of partnerships, companies or trusts between husband and wife. Should such arrangements continue from separation until the family law matter is resolved? Who should pay the tax? What protection will the client need from a nasty tax bill that may arrive after the settlement has been concluded? ¶18-620 Spousal maintenance: Under the Family Law Act spouses have an obligation to continue to support each other after separation to the extent that one spouse has a need and the other spouse has a capacity to pay. ¶18-700 Child support: Children born after 1 October 1989 or if their parents separated after that date fall under the child support scheme set up under the Child Support (Assessment) Act 1989. The scheme was overhauled in 2008 with far reaching changes. In some cases (and particularly for paying parents on the highest tax margin), the new changes have resulted in some parents’ child support liability dropping by as much as 40%. ¶18-705 Child maintenance trusts: A child maintenance trust is a trust that arises as a result of the family breakdown and has been set up to receive child maintenance payments. One of the principal benefits of a child maintenance trust is that it enables tax-effective income splitting to beneficiaries of a trust (including beneficiaries who are under 18 years of age) without attracting the penalty tax provisions. ¶18-715 Full and frank disclosure: The cornerstone of all property settlements is built on parties making full and frank disclosure of their financial position. Failure to do so could spell a disaster for the client’s credibility before the court and give their spouse a higher adjustment from the property pool. The adviser’s role is therefore significant in assisting the client to discharge their obligations of full and frank disclosure. ¶18-800 Third parties standing in the Family Court: A party that may be affected by a decision of the court has standing to intervene in Family Court proceedings. ¶18-815 Bankruptcy: The Family Court has jurisdiction to determine financial matters (property and spouse matters) where one of the spouses becomes bankrupt. The court can alter the rights of the trustee in bankruptcy in relation to the bankrupt’s property that has vested in the trustee in bankruptcy. ¶18-820 Binding financial agreements: Binding financial agreements can provide a good measure of asset protection on marriage or relationship breakdown because they provide certainty of result on division of assets. However, more recently lawyers have shied away from financial agreements. Why is this and how will this impact on clients? ¶18-825 Mediation: The Family Law Rules 2004 mandate that parties undertake Pre-Action Procedures

(PAP) before court proceedings are commenced. ¶18-835

¶18-005 Introduction to financial planning on family breakdown There are significant financial planning, estate planning and taxation issues and opportunities that financial advisers (and family lawyers) should be aware of and address on marriage or relationship breakdown for their clients. With 40% of first marriages ending in divorce and a higher rate of breakdowns for de facto relationships, divorce or relationship breakdowns can be emotionally and financially draining. Divorce is a reality for many financial planning clients. It is, therefore, incumbent upon advisers and lawyers to consider, plan and implement strategies that take into account marriage or relationship breakdowns when providing financial and estate planning advice to their clients before the marriage or relationship breaks down and be proactive if and when the client’s relationship or marriage fails. With wealth being passed down from one generation to the next, both during the lifetime of parents through inter vivo gifts or “loans” or “advances” or through an estate under a will, an adviser’s role in ensuring that the wealth is not lost or attacked by the spouses or former spouses of their client’s children is imperative. Lack of understanding of potential legal issues, and lax practices about documenting a client’s intentions, could spell financial disaster or at least a financial headache for the client or their adult child and potentially jeopardise the client/adviser relationship. Most clients choose to undertake estate planning because an adviser or lawyer identifies significant financial and other benefits to them and their family. A property settlement is the corollary in that it is a compulsory estate plan that clients are forced to undertake. Lawyers and advisers must not shy away when their clients’ relationships or marriages break down. Lack of action or awareness of the issues and opportunities by the adviser (or the lawyer, for that matter) of the financial impact and consequences of marriage or relationship breakdown could have a disastrous financial impact on the client and place a client’s future estate planning and retirement in disarray. With careful planning and cooperation between lawyer and adviser, clients’ financial costs could be kept at a minimum and leave their estate planning intact. This holistic approach that lawyers and advisers give to clients is akin to an insurance policy and crucial, regardless of whether or not divorce or separation will become a reality. From 1 March 2009, the laws on de facto relationships breakdown commenced in Australia with the exception of Western Australia. The new laws were a revolution as they represented a significant departure from the de facto laws that existed in some states. The laws apply to de facto couples and couples in same gender relationships. Under the new regime, the rights of de facto partners (including same-sex partners) are equated with those of married couples in relation to matters such as property settlement, superannuation splitting and spouse maintenance. De facto rights are now determined in the Family Court/Federal Magistrates Court, under the Family Law Act. It was the revolution that had to happen. Previously, some people may have entered into de facto relationships deliberately because of the difference in the laws that applied to de facto couples versus married couples upon a relationship breakdown. From 1 March 2009, that legal difference in financial consequences no longer applies. Accordingly, now more than ever before, there is a need to work through the mire with a view to try and preserve the client’s financial and estate plan. How will this be achieved? Have the Family Law Courts applied the long standing family law jurisprudence that was developed in cases referable to married couples and to de facto couples in the same way? Or are we seeing a divergence of opinions coming out of the courts? Some of the advice that an adviser should give a client include consideration of whose name the assets should be held in — the client, their spouse or an entity, and what involvement should the client/spouse have in the running of a business that is being set up by the adviser on behalf of the client. Traditionally advisers, and lawyers for that matter, have advised clients to have their spouse as partners

in the business. While this may provide tax benefits during the course of the relationship or marriage, consideration ought to be given by the adviser and the client as to whether or not this is a sound structure, given the risk of marriage or relationship breakdown. One of the considerations that need to be taken into account is the level of involvement of a non-financial activist spouse in companies or trusts set up by the financial activist spouse. This may have an ultimate bearing on the entitlement of that spouse in short relationships and short marriages. Financial advisers need to also understand who their client is. While this issue may seem trivial, in fact it has significant legal consequences. Invariably an adviser may be acting for the financial activist spouse and, as part of the financial planning for that spouse, advice is given that certain assets be purchased in the name of the non-financial activist spouse to minimise tax or for other such reasons. By doing so, the professional adviser has inadvertently become the adviser for both clients. However, the adviser believes that they are the financial activist spouse’s adviser. This is a misconception and has serious ramifications in relation to whether the adviser has discharged their obligation of assessing “the client” risk profile before investments are purchased in the name of the non-financial activist spouse; the level of contact between the adviser and the non-financial activist spouse; privacy issues and flow of information between the files of both clients; the role of the adviser on marriage breakdown; and whether the adviser can have or retain “both clients”. Purpose of Chapter 18 This chapter is a practical guide for advisers to use in their daily practice. Its purpose is to outline many of the estate and financial planning issues that advisers should be aware of and should incorporate in a checklist to examine and re-examine on behalf of their clients, not just at the first point of contact but throughout the duration of their professional relationship with the client. Given a client’s reliance upon professional advisers for advice, it is incumbent upon advisers to keep in mind the various financial and estate planning issues that are raised in this chapter whenever they give advice to clients. This is not to suggest that the adviser should become a de facto lawyer in giving advice to clients. It is about the professional adviser being attuned to the various legal ramifications of financial decisions that clients may make and being able to identify those issues. The adviser and the lawyer work together to ensure that clients make informed decisions.

¶18-010 The Family Court The Family Law Act 1975 (the Act) commenced in January 1976. The Act confers wide powers upon the Family Court in relation to property and financial resources of separated spouses. (In de facto matters, such powers were until 2009/10 conferred under the Property (Relationships) Act 1984 in New South Wales on the Supreme Court, District Court and Local Court (depending upon the pool of assets under consideration).) The word “property” is widely defined in the Act and includes real estate or shares in public or private companies, interest in trusts (where the spouse is a controller or de facto controller or a spouse is a beneficiary and where there have been regular distributions from the trust), interest in any business and bank accounts. The Family Court does not distinguish between assets held in the name of a spouse or in a company or trust controlled by a spouse or in circumstances where a company or trust, for instance, are controlled by third parties who are mere puppets for the spouse in Family Court proceedings. They are all “matrimonial property”. The decision of the High Court in Kennon v Spry highlighted the broad powers given to the court in relation to what “property” is. The decision may have some significant ramifications on trust law generally and also on areas that traditionally viewed trusts as separate entities. This includes bankruptcy cases where trusts are generally excluded from a property that vests in the trustee in bankruptcy. In Kennon v Spry, the High Court confirmed what the Family Court has done over the years — including trusts in the general property pool of the parties. The courts have endorsed the concept that a typical family trust is in effect for the family, and an individual cannot exclude their spouse from the fruits of that trust even if the trust was originally established to benefit the parties’ children.

Superannuation is “another species of assets”. In some cases, superannuation will be treated as if it is property but in other cases it will be treated as a financial resource. The nature, characteristics and form of a superannuation interest will determine whether super will be added to the property pool in Step 1 (of the four-step approach adopted by the court which will be discussed in ¶18-100) or will be taken into account in Step 3. This distinction is not cosmetic but has significant consequences for the parties and the overall property division. If the super value is included in Step 1, the property pool is enlarged. However, if the super value is characterised as a financial resource, then the value will not be added to the property pool in Step 1 but will be taken into account in a broad brush way in Step 3. Financial resources are taken into account in dividing the property pool between spouses in Step 3 in that the court examines whether there should be an adjustment to the notional property pool divided in Step 2 by reason of a party having an interest in a financial resource. Financial resources include being a beneficiary in a trust where the trust distributions to the beneficiary spouse are not regular, taxation losses, frequent flyer points or rewards points, long service leave and in some circumstances, superannuation. The powers of third parties in the court have been increased and strengthened in recent years. This is evident in the third parties powers in Pt VIIIAA, which allows third parties such as government instrumentalities and creditors to institute proceedings to set aside financial agreements or consent orders where it can be shown that the agreement or consent orders were entered into with an intention to defeat or defraud creditors. The court’s powers also extend to deal with bankruptcy matters where bankruptcy and family law collide. The court has the jurisdiction to deal with and make orders as to property or spouse maintenance from property that has vested in the trustee in bankruptcy. Since 1 March 2009, de facto couples’ (which include same-sex relationships) financial settlements and spouse maintenance are determined in the Family Law Courts. This applies to all couples in all states with the exception of Western Australia. For people living in some states, this will have some serious consequences on the property settlement or spouse maintenance outcome as determined by the Family Court versus what that outcome might have been if the case was determined in the state courts. On 9 December 2017 the Marriage Amendment (Definition and Religious Freedoms) Act 2017 amended the Marriage Act 1961 to redefine marriage as a “union of two people”. The amendment has enabled same-sex couples to marry. Same-sex couples who marry and separate will be subject to the jurisdiction of the Family Law Courts like heterosexual married couples.

¶18-015 What about de facto relationships? This chapter outlines the financial and estate planning and taxation issues and opportunities required for a married couple, and for couples who have separated after 1 March 2009. On a practical level, most of the chapter also applies to de facto couples who also separated before 1 March 2009. The law that commenced on 1 March 2009 (or 1 July 2010 if parties have geographical connections to SA) confers jurisdiction on the Family Court to determine financial settlements for de facto couples who separated after 1 March 2009 (or 1 July 2010 for SA). For those couples who separated pre-1 March 2009 (or 1 July 2010 for SA), the state courts will continue to determine those cases under the relevant state-based legislation. In NSW the relevant legislation will continue to be the Property (Relationships) Act 1984. For example, capital gains tax (CGT) rollover relief is available for de facto couples (who separated pre-1 March 2009) where transfers of property are made pursuant to a court order or a Domestic Relationship Agreement or Termination Agreement, just as it is available for married couples. Super splitting between separated de facto couples who separated before 1 March 2009 does not apply. Rather, super is taken into account as a financial resource under the relevant state law. However, if de facto couples separated after 1 March 2009, the Family Court does have the jurisdiction to split superannuation interests.

¶18-020 Estate and financial planning: Is it necessary?

One of the greatest areas where negligence claims could be levelled against professional advisers (including lawyers) relate to lack of advice on estate and financial planning prior to or on marriage breakdown. For instance, the risk of death is one of the financial planning issues that professional advisers should address with their clients on marriage breakdown. Since 2000, parties have been able to enter into Binding Financial Agreements (BFA) to ensure financial certainty in the event of separation. In theory this is a very useful tool of financial and estate planning. Unfortunately, this area of law has proved problematic for both clients and lawyers. The courts have frequently set aside the agreements due to invalidity, ambiguity as well as a raft of other reasons, including conduct by the financially able person where the courts have found such conduct to amount to duress, undue influence or that the pressure applied caused the other party not have proper consent to enter into the contract. Notwithstanding the attack on BFAs, they still are a useful tool for protection and certainty of outcome subject to safeguards that must be employed when negotiating a BFA. Lawyers as well as financial advisers could be at risk of negligence claims, not only from their clients, but from disappointed would-be beneficiaries if the client dies while the family law matter remains unresolved. Often the professional adviser is the first to know of the divorce, sometimes even before the client’s partner. In one case, while proceedings were still pending in the Family Court, one of the spouses died. At the date of separation, the family home was in joint names. Neither party had changed their wills as at the death of the husband, and the husband’s super death nomination was directed to his estate. By reason of the ownership of the house in joint tenancy, the wife took the title. In light of the nomination, and the absence of any claim from the children of the parties, the super trustee gave the husband’s superannuation death benefits to the estate. The will that had been prepared a significant time prior to the parties’ separation was still active so the wife was the sole beneficiary. Had the husband and the wife been divorced by the time that the husband died, the gift in favour of the wife under the husband’s will would have been void; however, this had not happened in this case. It should be borne in mind that divorce can only be applied for after the parties have been separated for more than 12 months. When people are in the midst of Family Court proceedings they generally delay filing the application for divorce until the property settlement and parenting issues are finalised. This means that parties could be separated and yet not divorced for periods of up to two if not three years, or even longer. Even if the parties were divorced, the wife would still have received the house by survivorship. In all likelihood the husband in the case did not intend for the above to occur. He was in the Family Court because he wanted a financial separation from his wife. The question that must be considered is whether the lawyer for the husband, or for that matter his professional adviser breached any duties to him. It is arguable that they should have advised that death meant the person he was trying to secure assets from would inherit everything, but that a few small steps could have avoided this outcome. In the example above, the husband could have severed the joint tenancy on separation, changed his will and changed his binding death nomination. These steps were simple yet necessary and it was crucial to have been taken or for the husband to have been advised upon and his mind be applied to those issues. This is where the adviser’s role becomes critical immediately upon separation. The adviser’s role, however, is not confined to providing advice of the type referred to above on marriage breakdown. The role of the adviser is dynamic and ever changing, and given changes in community standards and developments in society, the adviser needs to turn their mind to issues that impact upon their clients. One timely example relates to baby boomers assisting their Generation X and Y children by providing them with a deposit on a house or giving them money to set up a business. It is not unheard of, in Sydney at least, that parents give $500,000 and in some cases more to an adult child to assist them in buying a home. What is unclear in such cases is the basis of the advancement of funds. That is, did the parents intend the money advanced to be a gift or a loan? If a gift and the adult child was in a relationship already, was the money advanced to the adult child or to them and their partner? Is the partner aware of the nature of the advance? How is that proven in the future if the parties separate and the partner denies the advance as a loan because they were unaware of the terms of the advance or they were not involved in

discussions? Should both spouses be party to the loan agreement? When was the loan agreement entered into and does the time line reflects the matters outlined in the loan agreement? That is, was the agreement entered into after the advancement of funds and if so, do the words in the agreement suggest that monies will be advanced as compared to being an acknowledgement of funds having been advanced? Such matters are vital to defend an attack on a loan agreement. The adviser should give advice to the client to deal with the above issues. Advisers are constantly approached by clients asking them to liquidate assets for purposes such as the above. The adviser’s obligations extend to enquiring about the purpose of the advancement; how the advancement of the monies to the Generation X and Y children should be done; that documentary evidence should be put in place before the funds are advanced; whether interest rates will be charged or should be charged if certain conditions come into play. Even if the adviser does not know the legal implications of the above, the client should be advised (and such advice should be documented in a file note at least) to seek legal advice before the money is advanced. The above steps are necessary because the baby boomer client, while wishing to benefit their Generation X or Y child, would not want to see the funds lent or advanced being shared by a future spouse of their son or daughter in the event of marriage breakdown. A deed of loan evidencing the advancement of funds could be entered, which outlines the amount given in situations when the funds are repayable, such as marriage breakdown, sale of business, or death of the adult child. If the adult child later separates from their spouse, the money advanced would, prima facie, be a liability that will reduce the property pool to be divided between the spouses. If, on the other hand, the funds advanced were not the subject of documentation such as a deed of loan, the adult child and the parents will be put to the task of proving the existence of the debt and, if this is not established, the court may only accept that the money advanced was a gift. A monetary gift made on behalf of a spouse is taken into account by the court at Step 3; however, it does not receive the same weight as a loan that has the effect of reducing the pool of property available for distribution. The difference between gift and loan is not cosmetic. It is significant and substantive. In the case of Berghan & Anor v Berghan [2017] QCA 236 the Queensland Court of Appeal considered whether funds advanced by parents to their son was a loan or a gift. In that case the Court of Appeal stated that “Once one accepts that the money was paid on the express condition that it should be repaid … then the inescapable conclusion had to be that the resulting transaction was a contract of loan”. However, the devil is in the details. The loan terms in an agreement, conduct of the borrower and the lender family members and records kept to prove one’s case are just some of the issues the court will consider when determining the loan issue. Even if there is a deed of loan, that may not be sufficient to get the client over the line and have the debt deducted from the pool of property. This generally occurs because a spouse would argue that the debt is not a real debt or is not repayable. It is therefore crucial to consider whether the baby boomer should insist on there being a Binding Financial Agreement between their adult child and their spouse before the money is lent, which deals with the financial consequences relevant to the money to be advanced in the event of a breakdown of the relationship or marriage. There are a number of advisers who set up trusts on behalf of their clients by simply buying a standard trust deed without giving any consideration to the client’s particular circumstances. There is a potential negligence claim here as the adviser needs to consider whether or not the trust should benefit a child of the client (or that child’s spouse or former spouse), who should be the appointor or appointors of the trust, who should be the trustee of the trust and whether there should be any statements of intentions as to the reasons for the setting up of the trust to be incorporated in the trust deed. The High Court decision in Kennon v Spry is a reminder of how crucial it is to turn your mind to the structure as to who should be the appointor, the trustee and the beneficiaries from the outset rather than seek to amend the trust deed after the event. More recent cases in the Family Court have provided guidance on what happens when a trust is set up in a way that control is not conferred on a party but the control remains with, for example, the parents of the spouses. In a recent case the court found that such a trust was not property for family law purposes given that the husband did not have the control of the trust. In that case the trust owned the family home. The husband’s father set up the trust and bought the home which the parties used as their matrimonial home during the marriage. The wife was unable to convince the court that the Trust is the

alter ego of the husband as the husband’s father was in real control of the trust. Advisers should also be aware that their clients can enter into binding financial agreements (before the client gets married or into a relationship, during marriage or the relationship, following separation or divorce). Until 1 March 2009 for most states except SA and WA, couples used to enter into domestic relationship agreements. These types of agreements have the effect of ousting the court’s jurisdiction. They outline the financial consequences to each of the parties on relationship or marriage breakdown. Such certainty of outcome may be necessary because of the significant wealth that a client has as compared with that of their spouse, or because the client is in business with third parties where certainty that the business will not have to be sold as a result of a claim by a spouse in the future is necessary for the running of the business and the financial planning not only of the client but also of the business partners. In cases where one of the spouses refuses or simply does not want to enter into a binding financial agreement, there are practical steps an adviser can take to protect their client to some extent. One of the greatest debates in family law cases centre around the initial financial contributions of spouses. In cases where a client has some wealth and they cannot convince their spouse to enter into an agreement, then it is important for the adviser to ensure that there are objective records available to establish the client’s initial financial contributions. This can take the form of bank statements, share trading records showing the number of shares owned and the price at the end of the relationship or marriage, valuation of real estate, copies of the financial statements of any company or trust under the spouse’s control. These records must be kept in a secure place and not destroyed. They may come in handy one day if the client and their spouse separate. All of the above are examples of the value-added service that an adviser can and should provide to their client. Failure to identify the issues may result in a negligence claim against the adviser not only by the client but (as we saw above) by intended but disappointed beneficiaries.

PROPERTY SETTLEMENT ¶18-100 The four-step approach to property settlement Until 2012, the process for the making of orders pursuant to s 79 of the Act was commonly dealt with by reference to a four-stage process (see eg Hickey & Hickey). That process involved: (1) identification and valuation of the property of the parties (2) identification and evaluation of contributions to the property (including property no longer owned by the parties) (3) identification and assessment of the various matters in s 79(4)(d) to (g) including, to the extent they are relevant, the matters in s 75(2), and (4) consideration of matters of justice and equity. In the High Court of Australia decision of Stanford v Stanford [2012] HCA 52; [2012] FamCAFC 1 in 2012, the joint judgment of French CJ, Hayne, Kiefel and Bell JJ noted three fundamental propositions relevant to the operation of s 79. Those propositions were conveniently summarised by Bryant CJ and Thackray J in the decision of the Full Court of the Family Court in Bevan and Bevan [2013] FamCAFC 116. The High Court in Stanford has laid down three “fundamental propositions” which will provide useful guidance to trial judges in approaching the task under s 79. These were recited above, and could be summarised thus: • determination of a just and equitable outcome of an application for property settlement begins with the identification of existing property interests (as determined by common law and equity). • the discretion conferred by the statute must be exercised in accordance with legal principles and must not proceed on an assumption that the parties’ interests in the property are or should be different

from those determined by common law and equity. • a determination that a party has a right to a division of property fixed by reference only to the matters in s 79(4), and without separate consideration of s 79(2), would erroneously conflate what are distinct statutory requirements. It has been suggested that the four-step approach “merely illuminates the path to the ultimate result” and is not an approach that is mandated by the Act. Rather, it is the “mandatory legislative imperative (to reach a conclusion that is just and equitable) that drives the ultimate result”. Ultimately, it appears that Stanford requires judges to consider whether the jurisdiction be invoked. The preliminary step for a judge is to consider whether the s 79 enquiry will be engaged. In doing so, the judge will need to consider any equitable principles that would need to be attended to in relation to property registered in the name of a spouse and once this is done, consider the assets that each party has an interest in and look over the fence to see what contributions were made by the parties and assess whether an adjustment may be required to be made under s 79. In most cases, this will be an easy exercise in particular where parties have lived together for a long time and/or have children. The difficult cases will be where the marriage is short and/or where it is short and no child or children were born of the relationship or marriage. If there has been no merger of finances in such a marriage and the assets of the parties were purchased in names that one of the spouses considers that there should be no adjustment in favour of the other spouse, then it is open to that spouse to raise as a threshold argument that the court should not exercise jurisdiction. That spouse would argue that there ought be no adjustment to the property because the other spouse is not or will not be able to establish that they have an interest in the property of the other spouse because of the short relationship. This gateway question is gaining momentum and as time passes, there may be more cases on this point. Once the gateway issue is addressed and if the judge comes to the view that justice and equity dictates there being an adjustment of property, then the s 79 enquiry commences and the four-step approach is engaged. The four-step approach, being: (1) identification of the pool of property (including superannuation and tax liabilities, if applicable) (2) assessment of contributions that each of the parties have made to the accumulation of the pool (3) assessment of the s 75(2) factors for married couples. For de facto couples, there are identical provisions in s 90SF(3) — commonly known as “future needs factors”, and (4) examination of whether or not the result will deliver justice and equity between the parties.

¶18-105 Property settlement step 1: Identification of the property pool In identifying the property pool to be divided, the court generally looks at the property pool each of the parties had at the commencement of the relationship and their values (known as initial financial contributions), what happened to the initial property and the accumulation of property during the course of the marriage and since separation. It may be easy to identify the initial financial contributions of each of the parties; however, it is difficult to ascribe a value to the initial property that the court would accept unless valuation had been obtained at the time the parties entered into the relationship or shortly thereafter. Some advisers advise their clients to obtain a valuation of their assets as they are about to enter into a relationship or get married so that that could be evidence of that party’s initial financial contribution in the event the relationship or marriage breaks down in the future. Initial financial contributions by one spouse could have a significant impact on the outcome of the property settlement. The value of the initial financial contribution, the length of the marriage and the value of the property pool at hearing or settlement are important considerations as to the weight the court will give to initial financial contributions.

The court has generally adopted the value of the property pool as at the date of hearing (or as close as possible to that date). However, this may not be adopted in each case. In circumstances where the period between separation and hearing could be up to two years or longer, it may be prudent to obtain a valuation of property as at the date of separation, as well as at the date as close as possible to the hearing. This need not be the case for each parcel of property. It may be appropriate where a spouse runs a business and the business value has significantly increased from the date of separation as compared with the date of hearing. Superannuation is another example where valuation at the two dates should be obtained. This is relevant in particular to accumulation interests where a spouse has continued to make contributions into the fund or even in defined benefit super funds, post separation. As for the family home or other real estate, the Family Court has traditionally looked at the value of such property as at the date of hearing or as close as possible to that date rather than as at date of separation. This is because the court takes the view that any increase in the value of real estate occurs not by reason of any direct contribution by either of the parties but by reason of fluctuation in the property market. This position was confirmed in the decision of the Full Court of the Family Court of Australia in Jabour & Jabour (2019) FLC ¶93-898; [2019] FamCAFC 78. The Court must consider the myriad of other contributions. One wonders why the Family Court has taken this approach given that generally the court does not give any, or any significant weight to the spouse who continues to make mortgage repayments on the family home, notwithstanding that that spouse no longer resides in the family home following separation (as the court assesses that such contributions would have been offset by the homemaker and parenting role carried out by the other spouse during separation). Taxation liabilities Taxation liabilities have the effect of reducing the property pool by the amount of tax liability that either or both of the parties have to pay. This includes unpaid income tax and capital gains tax payable in relation to property sold. As for CGT that may become payable in the future by a spouse who will retain a particular property or shares in a company, the test that the court applies is whether or not the property is likely to be sold in the short to medium term by that spouse. If the answer is in the affirmative, then the court will generally reduce the pool of property by the amount of the CGT that would become payable on disposal. If the answer is in the negative, but the court is satisfied that the spouse will ultimately dispose of the property in the future, the court takes the CGT into account under s 75(2) (Step 3). Further, if the property was purchased for investment purposes, then the tax consequences have generally been taken into account in the first step, thus reducing the value of the property pool by the tax that would be payable. In certain circumstances, relief can be sought against the Commissioner to reassign tax debts owed by the parties of the marriage or de facto relationship as occurred in Commissioner of Taxation and Tomaras & Ors (2018) FLC ¶93-874; [2018] HCA 62. The High Court agreed with the Full Court that s 90AE enables the Court to bind the Commissioner and substitute one spouse for the other in relation to a debt owed to the Commonwealth. “Add-backs” “Add-backs” are notional property that the court adds back to the property pool which has the effect of enlarging the pool. Up until few years ago, add-backs occupied significant court time arguing over property that no longer exists and the reasons why this “property” ought to be added to the property pool. The Full Court has made it clear in more recent times that add-backs are a thing of the past. If the property no longer exists, then how could it be added back. This appears to be true and have been applied in relation to all except legal fees, waste (such as gambling) and “interim or partial property settlement Orders”. This is not to say that a party is precluded from arguing that certain property that was available at separation was dealt with or spent by one party unreasonably. This argument may have force if the party was the primary breadwinner during the relationship and post separation but again that also depends on the financial relationship that that party gave to the other party post separation. Invariably, with separation, the parties’ expenses will nearly double because of duplication in housing costs, utilities costs and other expenses. Family law proceedings can take a significant time to resolve. From date of filing an application to date of

trial is about three-year delay. Such delay is unfortunate but that is the reality. The consequences for parties though can be far reaching in particular in relation to partial or interim property orders (discussed in detail below). The Full Court of the Family Court in the decision of Bevan and Bevan made it clear that add-backs need to be dealt with “carefully, recognising the assets no longer exist, but that the disposal of them forms part of the history of the marriage — and potentially an important part”. The court went on to say that the court can take into account assets that no longer exist when the court looks at s 75(2) being the third stage in the assessment where the court looks at whether there should be an adjustment of the percentage notional division made by the court in respect of the contributions assessment in respect of the existing assets and superannuation. The court does this relying on s 75(2)(o) being “any fact or circumstance which, in the opinion of the court, the justice of the case requires to be taken into account”. To satisfy the court that an item of property that is no longer in existence should be added back, a party must be able to show that the item of property was in some way wasted by the spouse in control of the item. Examples of add-backs include legal fees paid from capital and assets that were wasted by a spouse, such as by gambling. In relation to legal fees paid, these will generally be added back if they were paid from capital. That is, if a spouse withdraws money from a savings account that the parties had as at the date of separation or sells an asset to pay legal fees, the legal fees are added back as notional property and will be taken as if there has been a partial distribution in favour of the spouse who paid the legal fees from that savings account or disposal of the asset. On the other hand, legal fees paid by a spouse from their earnings are not generally added back as they have been paid from that spouse’s earnings. However, a judge still has the discretion to add-back the legal fees paid from earnings or to exclude legal fees paid from capital. The circumstances of the case can, in some instances, sway judges to act in this manner. For example, in cases where a judge makes a finding of non-disclosure, and where one spouse pays legal fees from capital and the other spouse pays legal fees from borrowings, there have been cases where judges have ignored the legal fees paid and excluded the loan obtained to fund one party’s legal fees. Most advisers and lawyers also do not appreciate that when adding back certain property and then dividing the pool say equally, then the pool is enlarged by the amount added back and then divided between spouses. So the spouse pushing for an add-back could be sharing in something that no longer exists. If that spouse receives 60% of the total property, then an add-back would see that spouse receive 60% of something that no longer exists. Thus, proportionality needs to be considered as the add-back may hold up settlement of a family law matter because one party is convinced that a certain sum be added back. The reality is, in an add-back, both parties end up sharing the amount added back. This was never the intention. So perhaps consideration ought be given to depart from add-back and argue that a spouse has received a financial benefit and seek a higher contribution of what is left in the pool or seek an adjustment back against the other spouse from their share of the property pool. The latter would be better argued in cases such as waste. “Assets waste” “Assets waste” has become more popular in recent times in family law disputes. The court has to make a finding that the spouse who dealt with an asset did so with reckless indifference to the parties’ accumulation of the pool. It is difficult to establish that a spouse has been recklessly indifferent to the asset if the asset has been lost, given the test that the Full Court has formulated. An extreme example of waste is where a spouse gambles $100,000 at the casino and loses the money, then the court will add as notional property the amount of property that has been wasted by that spouse, namely $100,000. In the overall property division the court will take into account that that spouse has received the property that has been wasted as partial distribution. Gifts and inheritances Gifts and inheritances are treated differently to assets accumulated by spouses; however, the devil is in the detail. If the inheritance or monetary gifts or inter vivo gifts have been intermingled in the parties’ property pool, the court would still take them into account in assessing each of the parties’ contributions; however, it is difficult to see how that gift or inheritance is assessed or affects the assessment of

contributions as it is not an exact science. However, if the inheritance or gifts, for instance, were not intermingled or were received close to or following separation, the court can quarantine them from the property pool in Step 1 on the basis that the other spouse did not make any contributions to the inheritance or gift. Notwithstanding this, however, the court would still take such inheritance or gifts into account in Step 3 (s 75(2) factors). In Parnell & Parnell [2015] FCCA 2929, the Judge in reliance on common law principles established in Bonnici & Bonnici and Wall & Wall decided that the husband’s inheritance received six months after the end of the 20-year relationship should only be considered as a financial resource of the husband as a s 75(2) consideration, rather than included in the property pool on a global basis. The Judge was satisfied that the wife had made no contribution to the inheritance. The Judge made an adjustment in favour of the wife of 5% in acknowledgement of the husband’s greater financial position. In the case of Calvin & McTier [2017] FLC 93-791 the husband received an inheritance post separation from his late father’s estate which inheritance, at the time of trial, represented approximately 32% of the total asset pool. At first instance, in assessing the parties’ respective financial contributions, the Magistrates Court of Western Australia took into account the husband’s post separation contribution of the inheritance and made orders for the property pool to be divided 65% to the husband and 35% to the wife. The husband appealed the Orders and one of the issues before the Full Court of the Family Court was whether the husband’s post separation inheritance ought to have been included in the property for division between the parties. The Full Court held that property acquired post separation was not required to be treated in any different way and that it was the court’s discretion as to how to treat property acquired post separation.

¶18-110 Property settlement step 2: Assessment of contributions In assessing the parties’ respective contributions to the acquisition, conservation and improvement of the pool of property, the court assesses the following: • the parties’ respective initial financial contributions • gifts and inheritances received and their application • the direct and indirect financial contributions of each of the parties • the direct and indirect non-financial contributions of each of the parties, and • the parenting and homemaker contributions made by each of the parties. Initial financial contributions It is incumbent upon advisers to advise clients who, at the commencement of their cohabitation or marriage (whichever is earlier), own property that they should obtain valuation of the assets so as to be able to prove the value of the assets and therefore the value of their initial financial contribution in the event of separation. For businesses owned by a client, an adviser should advise the client to retain the financial statements and income tax returns for the business for the three financial years prior to the commencement of cohabitation or marriage as these documents can be used to value the business if the client and their spouse were to separate in the future. The initial financial contributions by one spouse, however, could be eroded by the contributions of the other spouse to a greater or lesser extent by the later contributions of the other party even though those later contributions do not necessarily at any particular point outstrip those of the other party. Example 1 A spouse’s initial financial contribution of $70,000, 20 years ago as compared to the parties’ current pool of property of $2m may have been eroded by the passage of time and the contributions made by the other spouse.

Example 2

One spouse made an initial financial contribution of $500,000 at the commencement of cohabitation five years ago. The current combined value of the property pool is now $1m. It could not be said that the passage of time and the contributions made by the other spouse have eroded the initial financial contribution. In such a case and assuming no children, the contributions could be assessed at approximately 75% to 80% in favour of the spouse who made the initial contribution.

Gifts and inheritances Gifts and inheritances received by a spouse during the marriage or after separation are treated differently by the Family Court. A gift or inheritance received either during the parties’ cohabitation and marriage or following separation is taken by the court to have been received by the person to whom the gift or inheritance is given rather than to the parties jointly. Gifts and inheritances therefore are assessed as a contribution by or on behalf of the spouse receiving the gift or inheritance as an indirect financial contribution. Depending on when the gift or inheritance is received and what the parties did with the gift or inheritance, the court has discretion to quarantine the gift or inheritance received from the pool of property in assessing the parties’ respective contributions. Example 1 If a spouse receives a property as part of an inheritance during the course of their relationship or following separation and that property remained quarantined throughout the parties’ cohabitation, marriage or following separation, then the court has a discretion to quarantine that property and not include it in the pool of property in assessing the parties’ contribution. This is because the other spouse did not make any contribution to the property in question. If the property inherited remains in the same state and the court excludes the property value from the property pool assessment, the court will take the inheritance received into account as a s 75(2) factor (Step 3).

Example 2 If the property, however, is sold during the course of the parties’ marriage and the proceeds intermingled with the parties’ other wealth, then the court will take the inheritance into account in assessing contributions rather than try and quarantine the value of the inheritance.

There may be circumstances where the adviser may advise a client who is about to receive an inheritance or a large monetary gift that such assets should remain quarantined and should always be identifiable so as not to lose their character during the course of the parties’ marriage in the event that the marriage breaks down in the future. This may work if the asset in question is property, but may be difficult if the asset received is a sum of money which the parties may apply towards reduction of a mortgage or the like. However, at the very least, the client should be advised to keep all documentary evidence to show the amount of the inheritance or gift received and how the inheritance or gift was applied. Financial contributions The financial contributions the court examines are the income that each of the parties receive during the course of the marriage and how that income was applied. The court also examines indirect financial contributions that are made for the benefit of spouses — for example, the parties occupying a home owned by one of the spouse’s parents without paying rent or paying below market rent. Generally, the court takes a broad brush approach in assessing contributions in long marriages or relationships. That is, the court does not mathematically adds up the income of each of the parties to reach a conclusion about each party’s contributions. This is important having regard to the High Court decision in Mallett where the High Court made it clear that contributions made by a spouse as a homemaker and parents are not inferior to financial contributions made by the other spouse. This applies even if the financial activist spouse earned $50,000 per annum or $1m per annum or even $10m per annum and the other spouse earned nil. Of course, the court’s assessment of contributions in short relationships or marriages will not be broad brush where one spouse’s initial financial contribution is overwhelming as compared with the other spouse. In that instance, the court may adopt an asset by asset analysis of the contributions each party made to arrive at an assessment of contribution. If, for example, one spouse’s initial financial contribution

was, say $5m and the other spouse’s was nil and they are together for, say five years and no children are born of the relationship or marriage. If the same property or pool remains at separation, the court may order little if anything by way of contribution. Depending on the needs of both parties, any adjustment may be also limited, if any. The outcome, however, may be different if the financially able spouse was ill during the relationship and was cared for by the other spouse who may have left their job to care for their spouse with consequences of them being able to rejoin the workforce. Non-financial contributions The non-financial contributions that the court looks at relate to matters such as home renovations carried out by the parties themselves or by a parent, relative or friend, thereby saving the parties’ money in paying contractors to do the work and where such work has added value to the property in question. Homemaker and parenting contributions In regard to the homemaker and parenting contributions, the court examines the parties’ respective contributions to caring for the children (ie each party’s role in raising the children) and attending to the homemaking activities such as cooking, cleaning, ironing and the like. The High Court said that homemaking and parenting contributions should be recognised not in a token way but in a substantial way. Accordingly, in most cases in the Family Court (let us call them the “house and garden cases”), generally the court assesses contributions made by spouses equally. This is notwithstanding one spouse was the financial activist and the other spouse attended to the homemaking and parenting role during the marriage. What the Family Court has developed in house and garden cases is a partnership analysis where each partner contributes to the partnership. If one spouse is the financial activist, then the other spouse freed that party to pursue wealth-making activities and thus to be a contribution not just to the welfare of the family but also to the generation of wealth. There have been cases determined by the Family Court going back to 1994 where the court gave loading to a financial activist spouse contributions entitlement because of what the court termed as “special contributions”, “business acumen skills” and “entrepreneurial skills”. These cases started with the case of Ferraro [1992] FamCA 64. However, in the year 2000 in the case of Figgins [2002] FamCA 688, the court started to distance itself from such concepts. The recent decisions of the Full Court in Kane and Kane [2013] FamCAFC 205 and Hoffman and Hoffman [2014] FamCAFC 92 appear to lay to rest such concepts and confirm that such a path was a “terrible mistake” that the court embarked upon and it should not go down that path. In 2015, in the case of Fields and Smith [2015] FamCAFC 57 (17 April 2015), the Full Court all but laid to rest the concept of special contributions. No doubt assessing homemaker and parenting contributions versus financial contributions is like comparing apples and oranges. What makes an apple better than an orange in a basket is difficult to say. In a way the court does not want to consider the quality of contributions that each spouse makes as that would be a very difficult and time-consuming task and is highly subjective. It is a very difficult task to evaluate contributions where one party was homemaker and parent and the other party was the financial activist as the evaluation and comparisons are not conducted on a level playing field. In essence, you are comparing two different matters, one can be quantified and the other cannot. In Kane and Kane, the parties had a net asset pool of $4.2m of which $3.4m was in a self managed superannuation fund (SMSF). The parties were married for 28 years and had four children; the youngest being almost 18 years at the time of trial. Shortly prior to separation, the parties sold a jointly owned company for $1,650,000. Of this sum, the amount of $1,060,400 was paid into the parties’ SMSF. The value of the SMSF at the date of trial was $3,420,294. The trial judge awarded the husband, a retired businessman, two-thirds of the SMSF, and the wife onethird having acknowledged “the assertion of the husband that the application of his acumen to investment decisions, which caused the superannuation fund to prosper, was a contribution of significance which differentiates his contributions from those of the wife and entitles him to a much greater share of the superannuation interests”. The Full Court of the Family Court overturned the decision, ruling the trial judge had given unacceptable

weight to the husband’s “special skill”. Deputy Chief Justice Faulks made the following comment “… the trial judge’s discretion miscarried because he took into account the ‘special skills’ of the husband in accordance with what he might reasonably have thought was authority binding on him, but which in my opinion should not have been”. Faulks DCJ further stated that “The reason for attributing (or not) special weight to the contributions of the husband in this case may be tested by asking whether, if the parties (before the husband invested what the learned trial judge found were joint funds) had been asked if they agreed that while losses would be shared equally between them, any gain would be disproportionally acquired by the husband there would have been agreement by the wife or the husband to proceed”. In Hoffman and Hoffman, the parties had net assets of almost $10m. The parties resided together for 36 years. The trial judge ordered that the assets be divided equally. The husband appealed submitting that his “‘[s]pecial [s]kills and [e]ntrepreneurial flair’ applicable to both substantial investments in real property and the share market” should have resulted in him receiving a greater proportion of the pool. The Full Court dismissed the appeal and rejected the notion that there was a binding principle of law relating to “special contributions” or that there was any legitimate guideline in respect of such contributions. The Full Court quoted O’Ryan J in D & D [2005] FamCA 1462 at [271] who stated “… the notion of special contribution has all been a terrible mistake …”. The above spells the death of the argument that has been advanced in big money cases about special contributions and therefore a greater entitlement to the financial activist spouse. However, that does not mean that, in an appropriate case, the court would not assess a party’s contributions as higher than 50%. While this will involve the court in an analysis of the contributions made and cause judges to go down a very rocky terrain of balancing contributions that can be measured versus those that cannot be measured by a known yardstick, namely in dollar terms, such cases may crop up. In the decision of Smith and Fields [2012] FamCA 510, Murphy J embraced not the big money cases concept that appeared in prior cases where there was an emphasis or finding of special contributions in one spouse, generally the financial activist spouse but the circumstances surrounding the accumulation of the parties’ wealth. In Smith and Fields, the pool was valued between $32m and $40m, which had been accumulated by the parties after nearly 30 years of marriage. The judge rejected the concept of special contributions, favouring instead an assessment of the form, nature and characteristics of the contributions made by each of the parties in ultimately awarding the husband 60% of the pool. His Honour said: “… it is then important to identify the nature, form, characteristics and extent of the contributions made by each of the parties by reference to the sub-paragraphs of s 79(4) of the Act — in effect to identify each and all of those contributions of varying types and extent and compare them. 30. Having done so, what remains is the exercise of discretion — to do what is just and equitable — as between these particular parties, not because one or the other has ‘special skills’ or because there is a ‘matrimonial partnership’, but because the identification and comparison of contributions and the ‘general counsel of experience’ pulls toward a particular result. Or, as Coleman J recently put it: ‘Given that the evaluation of contribution based entitlements inevitably moves from qualitative evaluation of contributions to a quantitative reflection of such evaluation, there will inevitably be a “leap” from words to figures. That is the nature of the exercise of discretion, whether it be in the assessment of contributions in the matrimonial cause, assessment of damages in a personal injuries case, or determination of compensation in a land resumption case …’”. Ultimately the judge took into account the husband’s stewardship of the company in reaching the conclusion that the parties’ contributions were not equal. His Honour said: “However, an analysis of those contributions points to a greater contribution having been made by the husband directly to the business, predominantly by reference to the design of the buildings which the business constructs and sells so successfully and to what I will call the stewardship of the company including the plainly clever strategies and planning that have given it such success and to the financial and other planning that have led to it doing, relatively speaking, remarkably well in very adverse macro-economic conditions. These are important contributions in which it is, in my view, both appropriate and just to distinguish between the parties to this lengthy union. I consider that

disparity to be particularly evident and pronounced in the period post-separation”. After reaching the view that the parties’ contributions were not equal, his Honour struggled as to how to jump from a qualitative assessment of contributions to a quantitative assessment. His Honour then said: “91. I consider that it is the ‘real worth in money terms’ that should inform the assessed difference in contributions between the husband and the wife in this case when the ‘leap’ described by Coleman J in Steinbrenner is performed”. His Honour then took the view that a 20% disparity between the husband and the wife was appropriate. In a pool of $30m, that disparity is worth in money terms $6m. That is, the first $6m would be received by the husband and the balance be divided equally. What is noteworthy is that Murphy J was one of the judges on the Full Court in the case of Hoffman and Hoffman. After assessing the contributions made by each of the parties to the acquisition, conservation and improvement of the property pool, the court notionally divides the property pool, for example, 50/50, 60/40, etc, and then moves to the next step. On appeal, the Full Court of the Family Court in Fields and Smith upheld the appeal and set aside the orders of Murphy J. The Full Court disagreed with Murphy J’s assessment of contributions of each of the parties as shown by the evidence. They rejected the concept that the wife’s contributions as a homemaker and parent and to the welfare of the family reduced once the children have grown up. Of those contributions, the court said that they were evolving and changing in nature. The Full Court was of the view that his Honour gave undue weight to the husband’s work in the company when the evidence did not support the conclusions he reached. Of contributions to the welfare of the family post separation, in the joint judgement of the Chief Justice Bryant CH and Ainslie-Wallace J, their Honours said: “93. If there was a diminution of the contributions of the wife to the welfare of the family postseparation, that was not the subject of any direct evidence. We do not suggest that her role had not altered, that much is evident from the fact the children had left home and she and the husband no longer belonged to a household in which mutual support was provided. But as senior counsel for the wife submits, the husband’s role changed as well during that period, and there was a lack of evidence on a number of other relevant matters. 94. Senior counsel for the wife submitted that, absent evidence, the approach of the trial judge to the wife’s diminishing contribution in her principal sphere is an argument which leads into murky waters or, as he submitted at [46] of the wife’s summary of argument, is ’controversial’ and would mean that in a marriage of a long duration the negative: … trend line perhaps starts when the children leave home, the parties are only having take away meals and there is a housekeeper and/or regular use of a laundromat. In other words, the value to be given to a contribution as homemaker either ceases or becomes less relevant, even in a case where, as here, there is no evidence that the further accumulation or conservation of wealth is the consequence of the post separation efforts of the ’male’/’breadwinner’/’business empire’ builder after the notional retirement of the primary homemaker and parent …”.

¶18-115 Property settlement step 3: s 75(2) “Future needs” After assessing the notional division of the property pool, the court examines s 75(2) (or s 90SF(3) in the case of de facto couples) which is commonly known as the “future needs factors”. Generally the factors the court takes into account include health and age of the parties, income-earning capacity of the parties, the care of a child or children, the standard of living that the parties were accustomed to during the course of the marriage, the child support being paid by the parent who has the children less of the time and any other factor. Not all the factors may be applicable in any one case. For instance s 75(2)(ha), which deals with bankruptcy, will not be relevant unless one of the spouses is bankrupt. Some of the factors are only applicable in spouse maintenance cases. Example In a $1m pool of property case, where the parties’ contributions have been assessed at 50/50 and where the parties have two

children under age 10 and the husband earns $200,000 and the wife does not work, it is likely that the s 75(2) (or s 90SF(3) in the case of de facto couples) factors will be approximately 10%–15%.

Under s 75(2), the court takes into account any financial resources that a party has, such as a spouse being a beneficiary in a trust, or inherited property that the court quarantined in Step 2. The adjustment made under s 75(2) (or s 90SF(3) in the case of de facto couples) varies depending on the circumstances of each case. Certainly it is true that if the property pool is not large, then the adjustment in percentage terms would be higher than if the property pool was large where the adjustment would, in percentage terms, appear low. This is because an adjustment of 10% on a $3m property pool equates to $300,000, which is quite a significant sum of money. In a property pool of, for example, $500,000, an adjustment of 20% is $100,000. It is important in the s 75(2) (or s 90SF(3) in the case of de facto couples) step that the court not fall in the error of making an adjustment for one spouse having significant superannuation in circumstances where, by reason of the adjustment itself, that spouse will no longer have a “significant superannuation pool”. Accordingly, the court has to be mindful when making the adjustment not to double dip in the assessment of contributions under s 75(2) (or s 90SF(3) in the case of de facto couples) factors.

¶18-120 Property settlement step 4: Justice and equity The final step in the approach is for the court to stand back from the exercise that it undertook in Steps 1 to 3 and examine whether the outcome will deliver justice and equity between the parties. The court has to consider not just the percentage division of the assets but also the monetary division so as to determine whether or not justice and equity will be achieved. However, it should be emphasised that justice and equity must be applied at every “step” in the exercise of the court’s determination of the matter. New approach to property settlements? The High Court in Stanford did not appear to endorse the four-step process that was endorsed by the Full Court of the Family Court in Hickey (2003) FLC ¶93-143. In determining applications under s 79, the High Court appear to have set out three fundamental propositions that it says must not be obscured: Is it just and equitable to take jurisdiction? “First, it is necessary to begin consideration of whether it is just and equitable to make a property settlement order by identifying, according to ordinary common law and equitable principles, the existing legal and equitable interests of the parties in the property. So much follows from the text of s 79(1)(a) itself, which refers to ‘altering the interests of the parties to the marriage in the property’. The question posed by s 79(2) is thus whether, having regard to those existing interests, the court is satisfied that it is just and equitable to make a property settlement order”. Section 79 must be applied in accordance with legal principles “Second, although s 79 confers a broad power on a court exercising jurisdiction under the Act to make a property settlement order, it is not a power that is to be exercised according to an unguided judicial discretion. In Wirth v Wirth (1956) 98 CLR 228 at 231–232, Dixon CJ observed that a power to make such order with respect to property and costs ‘as [the judge] thinks fit’, in any question between husband and wife as to the title to or possession of property, is a power which ‘rests upon the law and not upon judicial discretion’. And as four members of this Court observed about proceedings for maintenance and property settlement orders in R v Watson; Ex parte Armstrong (1976) 136 CLR 288 at 257: ‘The judge called upon to decide proceedings of that kind is not entitled to do what has been described as “palm tree justice”. No doubt he is given a wide discretion, but he must exercise it in accordance with legal principles, including the principles which the Act itself lays down’ …”. Judges must not conflate the statutory requirements “Third, whether making a property settlement order is ‘just and equitable’ is not to be answered by

beginning from the assumption that one or other party has the right to have the property of the parties divided between them or has the right to an interest in marital property which is fixed by reference to the various matters (including financial and other contributions) set out in s 79(4). The power to make a property settlement order must be exercised ‘in accordance with legal principles, including the principles which the Act itself lays down’ (R v Watson, Ex Parte Armstrong (1976) 136 CLR 248 at 257). To conclude that making an order is ‘just and equitable’ only because of and by reference to various matters in s 79(4), without a separate consideration of s 79(2), would be to conflate the statutory requirements and ignore the principles laid down by the Act”. The High Court concluded that adhering to the above three fundamental propositions “gives due recognition to ‘the need to preserve and protect the institution of marriage’ identified in s 43(1)(a) as a principle to be applied by courts in exercising jurisdiction under the Act. … These principles do so by recognising the force of the stated and unstated assumptions between the parties to a marriage that the arrangement of property interests, whatever they are, is sufficient for the purposes of that husband and wife during the continuance of their marriage. The fundamental propositions that have been identified require that a court have a principled reason for interfering with the existing legal and equitable interests of the parties to the marriage and whatever may have been their stated or unstated assumptions and agreements about property interests during the continuance of the marriage”. It is still too early to work out whether the Family Court will embrace the concepts elicited by the High Court given that Stanford was a unique case which involved an involuntary separation between spouses and where the spouse applicant was represented by a litigation guardian. How does the Family Court deal with de facto matters Under the old law as contained in the Property (Relationships) Act 1984 (NSW) (which law was similar in some of the other states laws on de facto relationships), the only matters that the state courts took into account in determining the financial consequences on relationship breakdown was the contributions that were made by each of the partners during the course of their relationship to the property pool. The property pool did not include superannuation; albeit in a recent Supreme Court decision it was suggested that while superannuation was a financial resource, it would or should have been taken into account in the property pool assessment (the difficulty with this is that for over 20 years superannuation was somewhat ignored in the assessment of contributions by lawyers acting for parties and the courts!). The state courts also developed a concept of compensation to counteract contributions made by a de facto partner. That is, in determining someone’s entitlement to the property pool based on their contributions the courts looked at the benefits that a spouse received from the other spouse such as gifts, holidays, a nice home to live in, restaurants attended, etc, to reduce that party’s overall entitlement. This made it difficult to see how relationships could be viewed as partnerships, a concept that was developed very early on in the family law sphere when the Family Court dealt with property matters. Even if we ignored the concept of compensation, the assessment of contributions by the state courts (be in Local, District or Supreme Court) have been so inconsistent that it was difficult to advise a client as to the likely outcome. State courts generally, however, were less robust in their assessment of contributions. Accordingly, a case that was determined in the state courts versus a case determined in the Family Court with the same set of facts, might have yielded significantly different results. The Family Law Courts have had a wave of de facto cases filed. There have been a number of cases that have been filed where the other spouse has taken issue with jurisdiction, namely whether the de facto spouse applicant can show that the de facto relationship was in existence for more than two years. In the case of Jonah & White [2011] FamCA 221, Murphy J found that parties who were in a relationship for 17 years were not de facto as that term is understood under the Act. His Honour found that they lacked the “coupledom” requirement that is so essential to establish jurisdiction. The matters that his Honour took into account as indicia of there being no de facto relationship (as against a relationship) were as follows: • each of the parties kept and maintained a household distinct from the other • no relationship between the applicant and the respondent’s children who were relatively young when the relationship commenced • the relationship between the applicant and the respondent was clandestine and the time spent

between the parties was spent (on either party’s case) very much together, as distinct from time spent socialising as a couple • the respondent emphasised during the relationship the limits of the relationship with the applicant and, in particular, if circumstances ever required him to “make a choice”, he would “choose” his wife and family over the applicant • despite the regular monthly payments (about $3,000 per month) and the payment of $24,000 the parties maintained no joint bank account; engaged in no joint investments together; and acquired, or maintained, property in their own individual names • the parties rarely mixed with each other’s friends • the respondent ran what seems to have been a successful business, in which for some (early) years, the applicant was employed, but the parties did not mix with the respondent’s business associates. After the applicant’s employment with that business had ceased, she had no involvement with it at all • there was virtually no involvement by the respondent in the applicant’s life in Brisbane (where she lived between about 1996 and 2006), and virtually no involvement by the respondent in the applicant’s life in Sydney where she has resided since 2006 • the respondent accepted that he hoped that the relationship with the applicant was permanent, he considered the relationship as an “affair” • there was very little time spent by the applicant and the respondent with the applicant’s family • the parties did not have a “reputation” as a couple; indeed, there was, on the evidence, very few public aspects to their relationship. The court made it clear that how one party regards a relationship (in this case, “an affair”) is not determinative as to whether or not a de facto relationship actually exists or not. Having regard to the facts in Jonah & White, the court found that the parties were not in a de facto relationship. The effect of this is the applicant could not make a claim for property settlement against the respondent. No doubt the aim of the new de facto laws is to unify the legal consequences that will flow on from a relationship or marriage breakdown. Of course, there will still be a range of possible outcomes; however, it is likely that the range of outcomes may be smaller. In addition to contributions, the Family Court will take into account the future needs of the parties. The future needs of spouses were not something that was taken into account under most of the state-based legislation as there was no such provision. In addition, superannuation was not capable of splitting under the state-based legislation. However, under the new amendments to the Family Law Act, the Family Court will deal with super for de facto couples in the same way as they do for married couples, and super is also capable of being split. Example Assume that Jack and Jill lived together in a de facto relationship for 15 years during which they accumulated $1m in property plus $200,000 in super, all of which is in Jack’s name. They have three children aged 12, 10 and 8. At the beginning of their relationship, neither Jack nor Jill had any assets. Assume further that Jill has not been employed since the birth of the eldest child 12 years ago. Jack is a manager and earns $100,000 per annum. If the matter had proceeded in a state court in NSW, the best result that Jill would have achieved would have been approximately 40%–50% of the property pool (excluding super) as the court would only have assessed contributions. Under the new laws, the Family Court might assess the contributions at 50/50 as to the property and super. The sting for Jack will come in the form of the s 90SF(3) assessment. The court will take into account the following matters: (1) Jack’s income (2) Jill’s inability to find gainful employment (3) the level of care that each of the parties are providing for the children. The above factors are likely to result in an adjustment of about 10%–15% of the property pool. That is, Jill could well end up with $600,000 to $650,000 of the property pool and a super split of $100,000. The court also has the discretion to trade-off cash for super and vice versa. If Jill shows the court that she needs, say, at least $650,000 to buy a home, the court may ultimately order a smaller

super split in her favour and adjust the balance from the available cash.

What about spouse maintenance? Under state law in New South Wales, for example, there was no legal obligation on de facto partners (including same-sex partners) to support each other financially. There were limited circumstances where a spouse could have applied for spouse maintenance and it was granted for very short periods of time, and generally in cases where the relationship was of significantly long duration and the partner required retraining for future employment or where there was a disabled child of the relationship. The state courts also took into account a partner’s entitlement to any Centrelink benefit in determining whether to grant spouse maintenance. That is, if a partner was entitled to or receives Centrelink benefits, then that would reduce that person’s needs. Under the new federal laws, there is a right to spouse maintenance. This is premised on the basis that parties have an obligation to support each other to the extent that one spouse has a need and the other spouse has capacity to pay. This is a significant departure and increase in the rights (and obligations) of spouses who live in a de facto relationship (including same-sex relationships). In determining whether or not a partner is entitled to spouse maintenance, the Family Court will consider a threshold question of whether or not a spouse has a need. Once that need has been established the court will look at the capacity of the other spouse to maintain the first spouse. Centrelink benefits are disregarded under the new law. Certainly under the new law it will be much easier to obtain a spouse maintenance order on behalf of a de facto partner than it was under the old law prior to 1 March 2009. Further, it is likely that the duration of the spouse maintenance order will be for a significantly longer period of time. A way out? A significant number of people have entered into de facto relationships deliberately and now they are thrown into the family law den. Financial advisers and accountants will need to reassess their clients’ needs including their asset protection, estate planning and financial planning, as the financial consequences of a relationship breakdown could spell disaster for their clients. One way to protect the client is to have them and their spouse (married, de facto or in same-sex relationships) enter into Binding Financial Agreements (BFAs). The effect of a BFA is to oust the court’s jurisdiction to deal with part or all of the property that is the subject of the BFA, as well as spouse maintenance and superannuation. Such agreements can give peace of mind to your client as they provide certainty of outcome in the event of a relationship breakdown. Interim or partial property settlement In cases where one spouse has control of the matrimonial property including liquid assets or assets that both parties agree will be sold whereas the other party has no assets to enable it to support itself or to run the litigation, an applicant can make an application for interim property settlement or interim costs. More recently, this has become the weapon of the financial controlling spouse seeking to carve out part of the property pool before a final trial or settlement where there is liquid funds and the funds are locked up. In Strahan & Strahan (Interim Financial Orders) [2010] FamCA 423, the Full Court revisited the principles that will be applied in relation to interim property settlement applications. The Full Court said that an interim property settlement involves two steps: (1) Identify the section in the FLA that gives the court the power to make the order: that is, is it an order that will be made under s 79 (property) or s 117 (costs) and ensure that s 80(1)(h) of the FLA was enlivened to allow an interim property settlement order under s 79. When considering whether to make an interim order, the overarching consideration is the interests of justice. That is, the court has to be satisfied that in all the circumstances it is appropriate to exercise the power. (2) Have regard to the matters in s 79 (FLA s 79(2) and 79(4)). A detailed enquiry, however, is not necessary but there must be some assessment of the factors in s 79. The interim order, however, has to be conservative so that the final outcome cannot be compromised by the interim order. Recently, judges have been quick to allow interim or partial property settlement orders to be made. These are orders applied for by one spouse to receive part of the available property on an interim basis. Generally, this is able to be done where there is cash at bank available and the funds are locked up

because they are in joint names. A spouse would apply for funds to be released to them for partial property. The applicant does not have to show a reason for wanting the money. The test adopted by the court in deciding whether to make an order is this: “the overarching consideration is the interests of justice”. This is a very loose concept and it appears to have been interpreted in this manner: if the order sought is less than what a party’s entitlement would be at a final hearing then they should be entitled to receive their entitlement “early” and deal with it as they please. The above appears to offend the concept of there being one property settlement not multiple or interim property settlement/s. Judges routinely say that when one receives their partial settlement then whatever they do with the property is their prerogative. That in itself can cause injustice if that is what judges do at a final trial. Take for example the spouse who did not work during the marriage, the other spouse’s income is not sufficient to support the other spouse for there to be an interim spouse maintenance order made, and the spouse receives say $150,000 in partial property settlement which they apply over three years of waiting for the final trial to come on in meeting their needs. The suggestion that the $150,000 is part of that spouse’s entitlement suggests that add-backs are back in a different guise. The more worrying though about the approach above is that if the court considers that the spouse already received part of their entitlement, that suggests that the discretion conferred on judges in achieving justice and equity is being curtailed and that goes against the principles in the Act. How could justice and equity be achieved if the pool available for distribution is $150,000 less than what it was or should be? The spouse who received the $150,000 spent the money on meeting their needs (thus obviating the need for the court to determine say a spouse maintenance application), the other spouse has more money available to them because the court did not make an order against them to support the other party. If that other spouse spends the surplus because of the court not making the order against them, that may then cause injustice against the spouse who received the $150,000.

SUPERANNUATION AND FAMILY BREAKDOWN ¶18-200 Superannuation splitting The Family Court has the power to split superannuation interests between separated spouses. There are a number of super interests that are unsplittable, such as small super interests of less than $5,000. The court still has discretion as to whether to split super or not. In the first supersplitting case decided by the Family Court after the amendments came in, the trial judge notionally split the super between the spouses 49/51 in the husband’s favour, but when applying Step 4 said that the wife needed to rehouse herself and the children and that she needed the cash now rather than keep it all in super. The judge, however, was still keen that the wife have some super in retirement and ultimately gave her 20% of the husband’s super interest and made up the balance of her super entitlement from the other property the parties owned. In the first supersplitting case decided by the Full Court of the Family Court, it was held that superannuation was property regardless whether or not a party seeks a superannuation splitting order. However, a differently constituted Full Court in the case of Coghlan and Coghlan (2005) FLC ¶93-220 held that superannuation was not property. The Full Court held that “Superannuation interests are another species of asset which is different from property as defined in s 4(1), and in relation to which orders also can be made in proceedings under s 79”. C v C highlighted the importance of understanding the nature, form and characteristics of a superannuation interest. That is, one has to consider whether: • an interest is in the growth or payment phase • an interest is capable of being commuted to a lump sum • the interest was accumulated before, during the relationship or marriage or a combination of both

periods • the interest is capable of being paid as a lump sum or pension or combination of both (where the interest is in the accumulation phase). Although the changes to superannuation in 2007 somewhat diluted the benefits of superannuation splitting, there are still situations in which super can still be used as weapon or shield by a spouse. The nature of a superannuation interest is that investments inside a superannuation fund is taxed concessionally. Investment earnings in a super fund, in the growth phase, is taxed at 15% flat rate. Earnings in the payment phase attract zero tax. Further, drawing down on a super interest after age 60 is generally tax-free. In any property settlement, the super spouse can use super as a way to extract a better deal. If for example, the super spouse knows that the non-super spouse needs the cash to rehouse themselves, they could offer part of their super interest as a way to reduce the cash payment ultimately to be made. By the same token, the super spouse would not want to split the super if they can offload an investment property to the other spouse, thereby retaining the super interest intact. For spouses who are concerned with meeting their future retirement plans, and those who are attuned to the significant tax benefits that super confers on them as they approach retirement, they may not be so willing to give up their super for the cash as they may never be able to accumulate the super they give to their spouse in a property settlement. It may be far more financially advantageous to them to retain the super and part with the cash, as super are taxed concessionally, and they will ultimately benefit in retaining their super. It is a balancing act whether to give up the super or retain it. Financial advice is crucial in this area. Opportunities for financial advisers The Family Law Regulations 1984 prescribe a method for valuing superannuation interests. Generally, there are no issues of valuation for accumulated funds. The valuation issues relate to defined, hybrid funds and self managed superannuation funds (SMSF). The Regulations do not provide a method for valuing SMSFs. These are valued generally by forensic accountants and if the fund owns real estate a property valuer is also required to value the real estate. The super splitting law recognises that some people will marry or have many relationships and divorce or separate more than once in their lives, and provides for splitting when this occurs. The Act allows for more than payment split to operate on the same superannuation interest. The provision works by setting an order of priority with earlier spouses taking before later spouses. The Act provides that super trustees must be provided with procedural fairness before a super split order is made. For a SMSF, this is not an issue. However, for accumulated or defined interests, it is important that a copy of the court’s application or terms of settlement is served on the trustees. The trustee has 28 days to respond as to whether or not the orders are such that the trustee can comply with them. There may also be circumstances where it would be appropriate not to split the super fund but to freeze the fund until a condition of release is satisfied. This may be because the member will retire within a short period of time or there may be issues as to valuation of the particular fund. In those cases, the member’s interest is flagged (ie frozen). Just as parties can now enter into financial agreements, they can also enter into superannuation agreements which can determine how in the event of separation their respective superannuation interests will be split. Generally, a financial agreement includes a superannuation agreement.

¶18-205 Binding death nominations and superannuation splitting Super splitting has effect despite any other law to the contrary and therefore will normally override binding death nominations. The major exception is where a payment is made by a trustee to or on behalf of a child. This exception has significant consequences for advisers and clients as a payment to a child will make a super interest unsplittable and therefore make a super splitting order worthless. Appropriate measures can be put in place to protect super splitting orders from binding death

nominations. Section 90ME(2) of the Act and reg 13 of the Family Law Superannuation Regulations 2001 provide that after the death of a member spouse, a super interest reverts to a child or to a person to hold on trust and apply for the benefit of a child either because a trustee decides at their discretion in favour of the child or because the trustee directly provides for that to happen. The federal government made a decision when setting up the new super splitting laws that payments to a non-member after the death of the member spouse are unsplittable if the benefit goes to children under the age of 18 and in some circumstances children over the age of 18. This is the case notwithstanding that there may be super splitting orders in place. This may alarm the adviser and the client but with careful planning the problem can be avoided. The Superannuation Industry (Supervision) Regulations 1994 (SISR) require trustees to report significant events to a former spouse. One such event that trustees must report on is where a member lodges a binding death nomination in favour of a child. The amendments also relieve a trustee of the duty to pay benefits in accordance with a binding death nomination if the trustee is aware that such a payment or the lodgment or failure to revoke the nomination would breach a super splitting order. The amendments referred to above may provide some protection; however, it is respectfully submitted that the protection is not complete. There are a number of ways the non-member spouse could be protected, namely: • following the making of the super splitting orders, the non-member insists on the rolling out of their new interest into a new superannuation interest. This will be achievable in accumulation interests. Where the member spouse’s interest is a defined benefit interest, most of those interests are now capable of being split and rolled out. In cases where the interest is not capable of being rolled out, it is important that the non-member spouse insist on a new interest being created in the member spouse’s interest which is merely an accounting exercise but such an exercise defines that nonmember’s interest in the member’s superannuation interest • that injunctions and indemnities be included in all super splitting orders or agreements to the effect that: – the member spouse is restrained from making or giving a binding death nomination in favour of a child or children, which in any way affects a non-member spouse’s interest under a super splitting order (if a nomination had already been given, the nomination can be revoked immediately insofar as it affects the super splitting orders). This does not mean that the member spouse cannot lodge a binding death nomination. The member spouse can do so but only in respect of their interest in the super fund without impacting on the non-member spouse’s interest under the super splitting order – that there be an indemnity that the member’s estate indemnify the non-member spouse in respect of any loss suffered by reason of the member lodging a binding death nomination. In multi-member superannuation funds where the interest is an accumulation interest, it is relatively easy to roll out a non-member’s interest into another fund. Most defined benefit funds now are also capable of being split. However, some do not allow a splitting of the interest such as state super. In that case, state super will create an interest for the non-member spouse within the member’s account. The non-member will not be entitled to receive their interest until the member spouse retires or satisfies a condition of release. This is not ideal and no doubt in due course this situation will be rectified. In relation to SMSFs, there may be taxation issues that would not make it effective to undertake a super split, or that because of the taxation issues, the level of the super split should not be as the parties thought it would be. For example, if a property has to be sold to effect the split, there are realisation costs and capital gains tax payable on the disposal which must be taken into account in any settlement. It is important to that note that in a multi-member superannuation fund, binding death nominations commonly have a life of three years and must be renewed every three years. Some funds do, however, provide for non-lapsing nominations which are binding upon trustee consent pursuant to s 59(1) of the Superannuation Industry (Supervision) Act 1993. In an SMSF, a binding death nomination does not typically have a time limitation.

TAXATION AND FAMILY BREAKDOWN ¶18-300 Realisation and taxation costs to be taken into account in property valuations The Full Court in 1998 in the case of Rosati (1998) FLC ¶92-804 set down principles in relation to the circumstances when the court ought to take into account potential capital gains tax which would be payable upon the sale of an asset. The Full Court in Rosati held: “It appears to us that although there is a degree of confusion, and possibly conflict, in the reported cases as to the proper approach to be adopted by a court in proceedings under s 79 of the Act in relation to the effect of potential capital gains tax, which would be payable upon the sale of an asset, the following general principles may be said to emerge from those cases: (1) whether the incidence of capital gains tax should be taken into account in valuing a particular asset varies according to the circumstances of the case, including the method of valuation applied to the particular asset, the likelihood or otherwise of that asset being realised in the foreseeable future, the circumstances of its acquisition and the evidence of the parties as to their intentions in relation to that asset (2) if the Court orders the sale of an asset, or is satisfied that a sale of it is inevitable, or would probably occur in the near future, or if the asset is one which was acquired solely as an investment and with a view to its ultimate sale for profit, then, generally, allowance should be made for any capital gains tax payable upon such a sale in determining the value of that asset for the purpose of the proceedings (3) if none of the circumstances referred to in (2) applies to a particular asset, but the Court is satisfied that there is a significant risk that the asset will have to be sold in the short to mid term, then the Court, whilst not making allowance for the capital gains tax payable on such a sale in determining the value of the asset, may take that risk into account as a relevant s 75(2) factor, the weight to be attributed to that factor varying according to the degree of the risk and the length of the period within which the sale may occur (4) there may be special circumstances in a particular case which, despite the absence of any certainty or even likelihood of a sale of an asset in the foreseeable future, make it appropriate to take the incidence of capital gains tax into account in valuing that asset. In such a case, it may be appropriate to take the capital gains tax into account at its full rate, or at some discounted rate, having regard to the degree of risk of a sale occurring and/or the length of time which is likely to elapse before that occurs”. Based on the principles or guidelines enunciated by the Full Court in Rosati above, the likelihood of a possible future sale is important in determining if and how, the potential CGT liability should be taken into account. Accordingly, if there is no intention or the evidence does not establish that a party has to sell a CGT asset then the court generally would ignore any CGT liability. On the other hand, if the court makes a finding that it would be inevitable to sell a property in the near future, then CGT will be taken into account in Step 1 which has the result of reducing the property pool. Having said this, it should also be noted that the court may still take the CGT liability as a s 75(2) (or s 90SF(3) in the case of de facto couples) factor if the court is satisfied that there is a significant risk that the asset will have to be sold in the short to mid-term. It should be noted that because a property has been valued using a particular method, it does not necessarily follow that the realisation costs or CGT liability will automatically be taken into account and therefore reduce the property pool. Certainly, the court can still take the realisation costs and/or CGT in Step 3 under the s 75(2) (or s 90SF(3) in the case of de facto couples) factor. In JEL v DDF, certain assets of the parties were valued on a tangible asset or asset realisation approach; however, the Full Court noted that this is only one of the matters to be taken into account under the

Rosati principles. The Full Court also noted the trial judge’s finding that while the assets had been “acquired with a view to making a profit” this did not equate to a finding that “all of the assets were acquired solely as an investment and with a view to ultimate sale for profit. To the contrary, it is clear that all of the assets were not acquired solely as an investment”. The Full Court referred to the parties’ former matrimonial home and their holiday home. Income tax In SPG and BAG (unreported, Full Court of the Family Court, 20 December 2001), the Full Court held that the principles in Rosati apply to income tax. The Full Court held that “where property which is held by a party or the parties to proceedings under s 79 of the Act was acquired as part of a business of acquiring, developing and the re-selling of real property for profit (ie essentially as trading stock of that business) then, in valuing that property for the purpose of the proceedings, the court should ordinarily take into account both the estimated realisation costs and the tax (in that case) ‘mainstream’ income tax which will ultimately be paid on its sale, even if the Court’s Orders leave the property in the hands of one party and the sale of it is not seen as an inevitable or even a likely consequence of those Orders”.

¶18-305 Are tax losses property? There are cases where a company controlled by either of the parties or both of them may have significant tax losses and the question that will arise in the proceedings is whether or not such tax losses are property or financial resources. This issue is significant because tax losses have the effect of reducing the tax that ultimately may be paid in respect of future profits earned by the company that would be retained by one of the spouses. In JEL v DDF (2001) FLC ¶93-075, the trial judge found that the husband would retain the benefit of losses in a company with a tax benefit of $1.866m while the wife would retain a benefit in another company of approximately $239,000. The trial judge found, on the evidence, that the tax losses did not constitute property as they had no immediate realisable value. However, the judge found that they constituted a financial resource of potentially significant benefit to the husband in the future. It appears that the trial judge thereafter omitted to return to this issue in the course of her judgment; however, on appeal to the Full Court, the Full Court made an adjustment in the wife’s favour under s 75(2) in the sum of $200,000 by reason of the husband’s significant tax losses that he would retain the benefit of.

¶18-400 Superannuation concessions and taxation The simpler super changes that came into effect on 1 July 2007 may have caused advisers to discourage their clients from agreeing to or offering a super split as part of an overall property settlement. However, that ignores the basic principles to a super split, namely that super can be used as a weapon and a shield. It is submitted that super splitting still has significant benefits. For a non-member spouse, the effect of a super split in their favour is to allow that person to have a super fund where in the usual course of events such an interest would not have been accumulated. Further, investing in a superannuation environment has significant tax benefits, including tax rates of 15% on earnings and nil on withdrawal of the investment after the member turns 60 years old. It is crucial that superannuation is brought to the forefront of discussions between the spouse and the adviser. From 1 July 2017, the maximum voluntary contribution that can be made by a spouse to their super fund which contribution is to be included in assessable income and taxed at 15% is capped at $25,000. This cap applies regardless of age or account balance. Any contribution over $25,000 is non-concessional and not included in assessable income. From 1 July 2017, non-concessional contributions are capped at $100,000 for members who are aged 65 or over (but under 75). Members who are under the age of 65 years are capped at contributions of up to $300,000 over a three-year period. The non-concessional contributions cap for members under the age of 65 also varies dependent on their total superannuation balance. Accordingly, if a spouse has to split say $100,000 of their super with their spouse, they may need up to four years to recover that money in the super environment. This is an important consideration when viewing the spouse’s retirement plans and whether they will be in a position to still maintain their estate

plan overall. From 1 July 2017, the non-concessional contributions cap was reduced to nil if the member has a total super balance greater than or equal to $1.6m at the end of 30 June of the previous financial year. If the member’s non-concessional cap is nil, any non-concessional contributions made plus any excess concessional contributions the member elects or is unable to have released are considered excess nonconcessional contributions and taxed at 47%. From 1 July 2018, some members aged 65 or older can access a “downsizer” non-concessional contribution to superannuation of up to $300,000 from the sale proceeds of a home for each spouse even if the balance of super is above $1.6m. Marital breakdown may present an opportunity for some members to benefit from the scheme aimed to reduce pressure on housing affordability in Australia. As a result of the significant concessions that superannuation provides, it can be used to a party’s advantage in any property settlement negotiations. Let’s consider an example where a party owns an investment property and has a superannuation interest and both are of similar value. If the member is able to survive financially without the benefit of say rent from the investment property, the member can offer their former spouse the investment property and retain their superannuation interest. The member will therefore retain the super interest and the nonmember will receive the investment property. The member will pay 15% tax on the earnings in the super fund. On retirement the member will receive the investment (made up of the capital invested as well as earnings) and pay zero in tax. The non-member will pay tax on the rent received (and this could be as high as 46.5% if the non member is on the highest tax bracket) and in the future when the investment property is sold, CGT will be paid on the investment property. (The non-member will inherit the investment property history and therefore the cost base will be the cost base of the member.) The tax for the non-member could be significant. Capital gains tax (CGT) CGT rollover relief is available where the super split is made under a court order or a Binding Financial Agreement (BFA). An in specie transfer of property, for instance, by one SMSF to another SMSF under a court order or a BFA will give rise to CGT rollover relief. However, in NSW at least, stamp duty is payable on the transfer of the property. However, if the asset owned by the SMSF is sold to effect the super split, CGT rollover relief will not apply. CGT will be payable and it will be levied on the SMSF which sold the asset. Therefore, caution is required to ensure that the CGT liability is taken into account at the time of settlement. If the asset has been held for more than 12 months, there is a 30% discount (not 50% as is the case with individual ownership) and then 15% is levied on the capital gain. The same would apply in relation to a member client’s interest in a multi-member fund whereby the super split will require the sale of shares or managed funds and the rolling out of the interest to the non-member spouse; however, the trustee may pay the split from inflows and therefore no CGT may be payable. Since 1 July 2007, spouses in a marriage breakdown have been able to transfer their entire in specie interest in a small superannuation fund (a complying superannuation fund with four or fewer members) to their former spouse without instant CGT consequences. The amendments to the CGT rollover in s 126140 of ITAA97 exempt existing personal contributions made in a fund by the departing spouse from giving rise to an immediate CGT event when transferred to another small superannuation fund. The amendments allow greater choice of fund options for the departing spouse. The rollover provisions as they stood until 30 June 2007 did recognise that the spouse who benefits from the payment split may have made their own personal contributions to the fund. The amendments now allow all the in specie interests of the departing spouse to be transferred to a new complying superannuation fund without there being an immediate CGT taxing point. The 2007 amendments recognised that it is often in the interests of spouses in a marriage breakdown not to continue to provide for their future superannuation arrangements through a single small superannuation fund.

¶18-450 Trusts and family breakdown

Where trusts are involved in a family breakdown, certain provisions are included in agreements or orders for the spouse exiting from the trust to relinquish their rights as to income and/or capital from the trust. If that spouse is a co-appointor of the trust, provision is also made for them to relinquish their rights as appointor. Such relinquishment does not generally cause resettlement of the trust and therefore does not trigger any tax issues. However, it is crucial that the trust deeds are reviewed to ensure that no resettlement of the trust will occur. A trust structure is a viable way for divorced or separated spouses to still run a trust for the benefit of their children. More and more cases are being settled on the basis that certain assets owned by a trust are retained for the benefit of the parties’ children. In those circumstances, there may be possibility for income distributions, for instance, to be made by the trust to the exiting spouse. If this is agreed to by the exiting spouse, care must be taken to ensure that that spouse remains entitled to receive the income as some trust deeds provide that the beneficiaries are, for instance, the appointor and their spouse. For considerations relating to family trust elections, see ¶18-615.

¶18-500 Investment properties and family breakdown Generally, investment properties are registered in the name of the spouse with the higher income so as to attract the most tax deductions. On marriage breakdown, there are tax savings to be made in relation to the disposal or transfer of the investment property. This assumes that the anti-avoidance provisions in Pt IVA of the Income Tax Assessment Act 1936 (ITAA36) are not contravened. Example An investment property has a cost base of $500,000. Assume that a sale price of $1,000,000 is achieved when the property is sold more than 12 months later. The property is jointly owned. Assume that the husband is on the highest tax bracket and the wife does not receive any income. The tax calculations are: Total capital gain = $1,000,000 (sale proceeds) − $500,000 (cost base) = $500,000 Therefore, the husband and wife each make a capital gain of $250,000. As the property has been held for more than 12 months, the assessable portion of the capital gain is: $250,000/2 = $125,000 each. Assuming the: Tax payable by husband = $58,125 Tax payable by wife = $38,975.

Another way to deal with the property is for one spouse to transfer their interest in the investment property to the other spouse pursuant to a court order. Stamp duty will not be payable on the transfer as there is a stamp duty exemption under the marriage breakdown.

¶18-505 CGT rollover relief on family breakdown Marriage or relationship breakdown CGT rollover between spouses Under s 126-5 of the Income Tax Assessment Act 1997 (ITAA97), there is a compulsory or automatic same assets rollover if a CGT event involves an individual taxpayer disposing of an asset to, or creating an asset in, their spouse (or former spouse) because of: “(a) a court order under the Family Law Act 1975 or a corresponding foreign law; or (b) a maintenance agreement under section 87 of that Act or a corresponding agreement approved by a court under a corresponding foreign law; or (c) a court order under a State law, Territory law or foreign law relating to de facto marriage breakdowns; or (d) something done under: (i) a financial agreement made under Part VIIIA of the Family Law Act 1975 that is binding because of section 90G of that Act; or

(ii) a corresponding written agreement that is binding because of a corresponding foreign law; or … (f) something done under a written agreement: (i) that is binding because of a State law, Territory law or foreign law relating to de facto marriage breakdowns; and (ii) that, because of such a law, prevents a court making an order about matters to which the agreement applies, or that is inconsistent with the terms of the agreement in relation to those matters, unless the agreement is varied or set aside”. Accordingly, any capital gain or capital loss from a CGT event is ignored if the marriage or relationship breakdown rollover happens. This applies to married couples and de facto couples (including same-sex couples). However, the changes to the definition of spouse (which commenced on 9 December 2008) have an operative date of 1 July 2009. This means that any transactions entered into prior to 1 July 2009, despite having arisen as a consequence of the breakdown of a same-sex relationship and entered into pursuant to a Family Court order, state or territory order, BFA are not eligible for capital gains tax rollover relief. If the asset is a post-CGT asset and the transferor disposes of the asset to a transferee spouse and the marriage or relationship breakdown rollover happens, the first element of the cost base (or reduced cost base) for the transferee will be the same as the cost base of the transferor at the time the transferee acquires the asset. Therefore, any costs incurred by the transferor in effecting the transfer (such as conveyancing costs) pursuant to the court order will form part of the first element of the cost base (or reduced cost base). Since 12 December 2006 CGT rollover relief has been extended to: (1) assets transferred to a spouse or former spouse under a financial agreement for married couples and domestic relationship agreements and termination agreements for de facto couples or a similar agreement under a corresponding foreign law or an arbitral award under the Family Law Act or a corresponding award made under a corresponding state law, territory law or foreign law, and (2) changes to the CGT main residence exemption so that a spouse who receives a property pursuant to a court order will inherit the history of the property. In relation to the second measure above, under the previous law as it stood prior to 12 December 2006, if a spouse received an investment property owned by their former spouse pursuant to a court order, and immediately upon receiving that property the spouse commenced to use the property as their main residence, then the CGT main residence exemption applied and that spouse would not pay CGT when they sold the property in the future. Under the amendments which came into effect on 12 December 2006, the transferee spouse inherits the property’s history so that CGT will be apportioned between the periods when the property was held for investment purposes and when it was used as the main residence with CGT being payable on ultimate disposal for the period the property was used for investment purposes. It should be noted that since 27 December 2000, s 87 maintenance agreements are no longer possible to be entered into and receive court approval. Maintenance agreements have been replaced by financial agreements. For CGT rollover relief to apply pursuant to a court order or a BFA, the transfer of a property must be to a spouse and not to a company or trust controlled by or associated with the spouse. While s 126-5 and 126-15 of the ITAA97 do not expressly require that there be marriage breakdown, this is implicitly required (see Taxation Determination TD 1999/49). CGT rollover on transfer from company/trust to spouse Section 126-15 of the ITAA97 extends the CGT rollover relief if the trigger event involves a company (the

transferor) or a trustee (also the transferor) and a spouse or former spouse (the transferee) of another individual because of: “(a) a court order under the Family Law Act 1975 or a corresponding foreign law; or (b) a maintenance agreement approved in accordance with section 87 of that Act or a corresponding agreement approved by a court under a corresponding foreign law; or (c) a court order under a State law, Territory law or foreign law relating to de facto marriage breakdown; or (d) something done under: (i) a financial agreement made under Part VIIIA of the Family Law Act 1975 that is binding because of section 90G of that Act; or (ii) a corresponding written agreement that is binding because of a corresponding foreign law; or … (f) something done under a written agreement: (i) that is binding because of a State law, Territory law or foreign law relating to de facto marriage breakdowns; and (ii) that, because of such a law, prevents a court making an order about matters to which the agreement applies, or that is inconsistent with the terms of the agreement in relation to those matters, unless the agreement is varied or set aside”. Accordingly, there is also an automatic or compulsory marriage breakdown rollover if the marriage breakdown conditions between spouses are met, except that the transfer is from a company or trust associated with the parties to a spouse or former spouse.

Caution Notwithstanding the above rollover relief, there are other significant consequences in respect of transfers of property owned by a company or trust to a spouse pursuant to court orders which are dealt with under the heading “Division 7A consequences” (¶18-510).

Marriage or relationship breakdown CGT rollover on transfer of shares CGT rollover relief is also available on transfer of shares (in public and private companies) if made pursuant to court orders. Depreciation rules and marriage or relationship breakdown Assets that are depreciated, such as plant and equipment or motor vehicles, are not generally subject to CGT; however, income tax may be payable on any excess value over and above the written down value. If these assets remain with the controlling partner, CGT rollover relief is available. However, the CGT rollover relief does not apply for trading stock of the transferor’s spouse’s interest in that trading stock. CGT rollover not appropriate in all instances There may be instances where it would be beneficial for the controlling spouse to buy out the exiting spouse rather than rely on the CGT rollover relief. For example, if the business was started by the parties and has increased in value over the years, it may be in the controlling spouse’s interest to crystallise the

value of the business at marriage breakdown rather than take advantage of the CGT rollover provisions. This is especially in relation to business goodwill. As the business was started by the parties, the goodwill cost base is nil. If the controlling spouse buys the exiting spouse’s interest in the partnership, CGT concession rules may apply (where family business assets do not exceed $6m) and this may be for the benefit of not just the controlling spouse but also the exiting spouse. CGT rollover relief may not work in certain cases As outlined above, parties are entitled under the taxation legislation to have certain classes of property transferred without triggering a capital tax event — with that capital tax event being postponed to rollover until the time comes for the spouse to dispose of the property in the future. However, careful understanding and planning is required to ensure no surprises after a settlement has been effected. CGT rollover is available where the settlement is done by way of court orders or a financial agreement. The CGT rollover is available to certain transfers such as a transfer of property from one spouse to the other, a transfer of property from a family discretionary trust to a spouse who is a beneficiary of the trust. CGT rollover however is not available where the transfer of a property is a transfer from a company owned by a spouse to the other spouse. Such transfer attracts CGT payable by the company so that the transfer is considered to be a disposal despite the fact that the transfer is pursuant to a court order. Further, identification of the entity that owns a property to be transferred is crucial to ensure no unintended tax consequences. In Ellison v Sandini Pty Ltd, the husband and wife entered into final property orders pursuant to s 79 by consent. The orders joined Sandini Pty Ltd (Sandini) as trustee for the Ellison Family Trust to the proceedings and the following order was made: “Within 7 days of orders being made Sandini [as trustee for the Ellison Family Trust] do all acts and things and sign all documents necessary to transfer to the wife 2,115,000 Mineral Resources Limited Shares [MIN]”. However, as it turned out, Sandini was not the trustee of the Ellison Family Trust and was instead the trustee of the Karratha Rigging Unit Trust (KRUT). Sandini did own more than 35 million shares in MIN, in its capacity as the trustee of the KRUT. Subsequent to the Family Court orders being made, the wife emailed the husband and requested that he transfer the shares in MIN to a company controlled by her, being Wavefront Asset Pty Ltd, rather than to her personally. The husband complied with the wife’s request and the share transfer was registered in October 2010. The husband, Sandini and other associated entities applied to the Federal Court for a declaration that Sandini was entitled to rollover relief from the capital gains taxation that would otherwise be payable on the transfer of the shares. The primary judge granted the declaration sought by the husband and his entities. The Commissioner and the wife appealed to the Full Court of the Federal Court of Australia. The issue on appeal was whether Sandini as trustee of the KRUT was entitled to rollover relief pursuant to the Income Tax Assessment Act 1997 (Cth) (ITAA97). Appeal Justices Jagot and Siopis allowed the appeal and Siopis J agreeing. Justice Jagot set out the relevant legislative extracts and reviewed extensive authorities. Her Honour summarised that the matter involved answering three questions, as set out at para 35 of the judgment. The first question was whether the Family Court orders meant that a change of ownership as referred to in s 104-10(2) of the Income Tax Assessment Act had occurred so that the wife became the beneficial owner of the MIN shares at the time that the order was made (as opposed to the time when the share transfer was registered). If the change of ownership took place upon the Family Court orders being made (ie the wife personally became the beneficial owner), the husband and his entities would undeniably be entitled to rollover relief. Section 104-10(2) of the ITAA provides that CGT event A1 happens if a person disposes of a CGT asset. A person disposes of a CGT asset if a “change of ownership occurs from you to another entity”, which

Jagot J included a change of beneficial ownership. While there was no doubt that a change in the legal ownership did not take place until the signing and/or registration of the share transfer, the question was whether the making of the Family Court orders resulted in a change of beneficial ownership upon the making of the orders. Contrary to the primary judge, Jagot J found that the Family Court orders in this case did not have the effect of a change of beneficial ownership. Instead, the change of ownership did not occur until the signing and/or registration of the share transfer. The primary reasons for this conclusion were as follows: 1. The case involved shares in a publicly listed company, as opposed to previous authority on this point in the family law context which involved the transfer of real property. The “effect of an order under s 79 will depend on the terms of the order and the nature of the property”. 2. For a share to be held on trust, there must be certainty as to the property bound by the trust, which is difficult in the context of shares which do not need to be numbered and certified as was the case for shares in MIN. Instead, the shares were fungible or interchangeable. 3. The “weight of authority is that there can be a valid trust over a fungible pool of assets provided the assets and relevant proportions for the different beneficiaries are identified with sufficient certainty. The better view is that for the requirement of certainty to be satisfied the trust must be over all of the fungible assets in the pool, the beneficial co-ownership proportions reflecting the respective interests of the beneficiaries”. 4. For a bare trust to constitute a change of ownership in the relevant sense, “the rights vested in the beneficiary must be capable of supporting the grant of equitable remedies the equivalent of ownership, including preventing the trustee from dealing in the relevant proportion of the asset pool other than in accordance with the beneficiary’s directions”. 5. Even if the Family Court orders could be construed as relating to the MIN shares Sandini owned (noting the error in making the order against the wrong party), a “necessary question is what a court of equity would do”. The matters that pointed against the husband in that respect were inter alia: a. the shares were an asset freely traded in a public market, and Sandini could therefore do all acts and things necessary to transfer shares to the wife irrespective of whether they were owned by Sandini at the time of the orders b. the orders only referred to “2,115,000 [MIN] shares” and not to “2,115,000 of the MIN shares owned by Sandini” c. the orders did not require Sandini to transfer any shares to the wife, but required Sandini to do all acts and things and sign all documents necessary to transfer the shares to the wife d. the orders did not suggest that Sandini holds all the shares it owns in MIN on trust, the beneficiaries being the wife as to 2,115,000 and Sandini as to the balance e. the orders did not prevent Sandini from dealing in any MIN shares that it owned, and f. the orders referred to the shares being transferred to the wife. The rights created were personal to the wife and it was not apparent that those rights were assignable. Given that the Family Court orders did not result in a change of ownership at the time they were made, the second question was whether the share transfer from Sandini to the wife’s entity engaged the rollover relief provision in s 126-15(1)(a) of the ITAA which relates to transfers because of an order pursuant to the Family Law Act. That rollover relief refers to a trigger event which involves a company (the transferor) or a trustee (also the transferor) and a spouse or former spouse (the transferee) because of a court order under the Family Law Act.

While the primary judge held that the rollover relief applied, Jagot J disagreed and concluded that the rollover relief did not apply. This reasoning was largely based upon the fact that the share transfer had been executed in favour of the wife’s company and not the wife personally. Justice Jagot concluded that the terms of s 126-15 requires the spouse or former spouse to personally be the transferee for the rollover relief to apply. Further, the trigger event had to occur “because of” an order of the Family Court which her Honour found did not take place in the circumstances of the “wholly inefficacious” orders (owing to the joining of the wrong entity) irrespective of what the parties subsequently agreed. The third question was whether s 103-10(1) of the ITAA applied, which would have resulted in rollover relief applying. Again, Jagot J found that the provisions did not apply. Overall, Jagot J concluded that: “… the appeals must be allowed and consequential orders made. Sandini was not entitled to the rollover relief provided for in s 126-5 of the ITAA 1997, by operation of s 126-15 of that Act, because the 21 September 2010 orders of the Family Court did not constitute CGT Event A1, and the subsequent transfer of shares by Sandini to Wavefront which did constitute CGT Event A1 did not engage s 126-15(1)(a) of the ITAA 1997 as [the wife] was not involved in the transfer as transferee and the transfer did not occur because of the Family Court orders”. Justice Logan delivered a dissenting judgment, in which his Honour agreed with the primary judge and found that the appeal ought to be dismissed. The key area of disagreement was as to whether the making of the Family Court orders resulted in a change of ownership at that time, by way of a change of beneficial ownership. In agreeing with the primary judge, Logan J concluded that the making of the Family Court orders did result in the requisite change of ownership at that point and that the rollover relief was therefore available to the husband and his entities. Justice Logan further commented that the final property orders made by the parties were made “seemingly, without any attention to the possible federal revenue law consequences of the order proposed, made and later amended, [which] gives pause for thought about the risks of over-specialisation in both the practising profession and the judiciary”. The appeals of the Commissioner and the wife were allowed and the declaration made by the primary judge was set aside, as was the primary order for costs. The parties were ordered to file written submissions in relation to the costs of the appeal. The husband applied to the High Court of Australia for special leave to appeal. Special leave was refused. Exemptions from CGT In general terms the following assets are exempt from CGT: • assets acquired before 20 September 1985 • certain categories of motor vehicles and motor cycles • personal use assets with acquisition costs of less than $10,000, and • principal place of residence (subject to various restrictions). CGT and de facto matters Property transfers pursuant to court orders or Domestic Relationship Agreements or Termination Agreements (these being equivalent to BFAs) under the Property (Relationships) Act 1984 (NSW) and other similar legislation in the various states, will also trigger CGT rollover relief under s 126-5 and 126-15 of ITAA97.

¶18-510 Deemed dividends and company loans Division 7A consequences While capital gains tax rollover relief may apply to transfers of property from a company or a trust to a spouse associated with the company or trust (and for this matter, stamp duty exemptions may apply as will be discussed below), there are significant tax consequences that will flow from a transfer of property owned by a company or trust to a spouse pursuant to court orders.

Division 7A of ITAA36 deals with three situations where a company will be deemed to have paid a dividend to an associate namely: (1) payments made by the company to a shareholder or shareholder’s associate (s 109C) (2) amounts lent by the company to a shareholder or shareholder’s associate (s 109D and 109E), and (3) amounts of debts owed by a shareholder or shareholder’s associate to the company that the company forgives (s 109F). The effect of Div 7A is that, if for instance, a property owned by a private company is transferred to a spouse even pursuant to a court order, then Div 7A deems that transfer as a dividend payment upon which the company would have to pay tax at the current rate of 30%. The transferee spouse will also have to pay tax at their own marginal rate, although they will receive a franking credit in relation to the tax already paid by the company in respect of the transfer. Certain payments may qualify as excluded payments. That is, Div 7A does not apply to the payment by the company. Some of the most common exclusions are: • loans made from one private company to another private company (s 109K) • payment of a genuine debt (s 109J) • loans made on commercial terms (s 109M), and • loans which meet specified minimum interest rate and term criteria (s 109N). A payment of a genuine debt (s 109K) takes place where the payment: (a) discharges an obligation of the private company to pay the money to a person, and (b) is an arm’s length amount required to be paid to discharge the obligation. A court order that provides for a private company to pay a spouse a sum of money is taken to be a s 109J type of payment (see Australian Taxation office (ATO) Binding Private Ruling no 46679). The liability of the private company cannot, however, be satisfied by an in specie transfer of a property (such as shares or real estate). It must be a cash payment. Notwithstanding the interpretation given to s 109J, it is strongly recommended that a private ruling be applied for in each case where there will be an order involving the payment of an amount of money by a private company to a spouse. In addition, the following also applies: (1) a payment can be made from a company to one of the shareholders or their associate (eg exspouse) and the payment can be a franked dividend. Generally when a company pays a dividend, it must pay it to every shareholder. Under the amendment, a dividend payment can be made to only one shareholder if the payment arises out of marriage breakdown (s 109RC of ITAA36) (2) loans or debt forgiveness as part of a property settlement will not trigger Div 7A of ITAA36 (3) the Commissioner has a discretion to either disregard deemed dividends or allow them to be franked where they have been triggered by honest mistakes or omissions by the taxpayer. This amendment applies from 1 July 2001 (s 109RB of ITAA36). Company loans Loans to associated persons of a company may become the subject of the deemed dividend provisions. Associated persons include shareholders, their spouses and related entities. Section 108 of ITAA36 applies where a private company pays an amount to an associate as an advance or a loan or credits an amount to an associated person and the Commissioner forms the view that the amount represents a disguised distribution of profits. In those circumstances, the payment received will be deemed as an unfranked dividend paid by the company to the person and therefore assessable to

income tax by the recipient. Division 7A provides that where there is a loan from a company to an associated person, a deemed dividend will arise from the company unless either the loan is repaid before the end of the financial year, or if there is a genuine commercial loan evidenced in writing with all of the relevant terms and interest conditions. In addition, the loan must be repaid within seven years from the date that the loan was issued (if unsecured) (a secured loan can be for 25 years), otherwise the loan will be deemed as dividends in the hands of the associated person. When dealing with loan accounts the following should be taken into account and considered: • forgiveness of the loan is not an effective way of dealing with the loan account as this will trigger the deeming dividend provisions • consideration should be given as to whether loan accounts should be brought to nil by declaring a dividend payment in favour of the spouse in whose name the loan account is in; however, it should be noted that this would trigger income tax liability but such income tax will be less than if s 108 operates • the loan could be assigned to the other spouse who will retain the company; however, it is important to obtain the relevant indemnities to ensure that the spouse exiting the company is protected from any tax liabilities that may flow on from such an assignment. Under s 109RB, the Commissioner still has the discretion to allow the dividend to remain franked and/or disregard Div 7A. The introduction of Taxation Determination TD 2019/D9 released on October 2019 by the ATO expresses a new view that para 245-40(e) of the ITAA excludes a debt forgiven for reasons of natural love and affection from the application of the commercial debt forgiveness provisions. Previously, a debt owed by a child to their parent’s company could have been forgiven by the parent’s company for reasons of natural love and affection that the parent feels for their child, provided the parent is the sole director and shareholder of the company. The effect of the new ATO view is that the parent’s company cannot forgive the debt to the child “for reasons of natural love and affection” for the purpose of the exception.

¶18-515 Part IVA considerations when advising on family breakdown An important matter that must also be addressed in any family law matter which involves tax restructuring or tax advice is the potential impact of the general anti-avoidance provisions of Pt IVA of ITAA36. The most important ingredient which will attract the operation of Pt IVA is where it could be concluded that a participant in the scheme had the sole or dominant purpose of obtaining a tax benefit for the taxpayer. The anti-avoidance legislation is concerned with the following aspects of the scheme: • manner — this refers to the manner in which the scheme was entered into or carried out • form and substance of the scheme — this requires the Commissioner to look at the commercial reality as well as the legal or literal form of the scheme • timing — this refers to the time at which the scheme was entered into and the length of the period during which it was carried out • result achieved — this refers to the result that would have been achieved by the scheme if Pt IVA did not apply • change in the financial position of the taxpayer that has resulted or may reasonably be expected to result from the scheme • change in the financial position of the person connected with the taxpayer • any other consequence for the taxpayer connected — ie non-financial consequences, and

• nature — if there is a connection between the taxpayer and the other person, the connection may be of a business, family or other nature.

STAMP DUTY AND FAMILY BREAKDOWN ¶18-600 Stamp duty exemptions on marriage or relationship breakdown Stamp duty exemptions vary between each of the Australian states and therefore it is important to ascertain the stamp duty consequences as well as the stamp duty exemptions in the state where the property the subject of any property settlement is located. All references in the following paragraphs are based on the duties law for NSW. Stamp duty exemptions on marriage breakdown Section 68 of the Duties Act 1997 (NSW) provides exemption from duty on transfer of matrimonial property following the breakdown of the marriage or relationship. Similar provisions apply in respect of breakdown of domestic relationships pre-1 March 2009. Notwithstanding the changes that came into effect on 1 March 2009 in relation to de facto couples, at least in NSW the Duties Act 1997 has not been amended to reflect changes to the definition “matrimonial property”. This term remains defined as outlined below. However, it is submitted that this should not in any way affect the exemptions to payment of stamp duty. For the exemption to apply, the property transferred must be “matrimonial property”, that is to say property of the parties to the marriage or of either of them. This has been interpreted widely by the court in Commissioner of Stamp Duties (NSW) v Bryan (1989) 89 ATC 4529. In that case, the property was transferred by the trustee of a family trust to one of the parties to the marriage. The trust was discretionary and provided for a gift over to parties to the marriage subject to the trustee’s discretion. At the time, the only beneficiaries named were the husband and the wife; however, the trustee had the power to add new beneficiaries. At both first instance and on appeal to the Court of Appeal, it was held that the property transferred was matrimonial property and the exemption applied. Where property is transferred by a company to a spouse, the property of the company is considered to be matrimonial property, if the only members of the company are the parties to the marriage. If only one party is a member of the company, the voting power of the spouse who owns the shares would be examined. Pursuant to s 68(1) of the Duties Act, no duty is chargeable in respect of a transfer of matrimonial property if: (a) the property is matrimonial property. Property includes real estate as well as shares in private companies (b) the transferee is a party to the marriage (and this includes a child or children) (c) the marriage has either been dissolved or annulled or in the opinion of the Chief Commissioner, has broken down irretrievably (d) the transfer is affected by or in accordance with: (i) a financial agreement under the Family Law Act (ii) a court order (iii) an agreement that the Chief Commissioner is satisfied has been made for the purpose of dividing matrimonial property as a consequence of the dissolution, annulment or breakdown of the marriage, or (iv) a purchase at public auction of the property that immediately before the auction was matrimonial property where the public auction is held to comply with any such agreement or order.

Section 68(4) provides for refunds to be made by the Chief Commissioner in respect of duty charged following breakdown of marriage (or pursuant to s 68(4A) in respect of the break up of domestic relationships). The circumstances where the Commissioner can reassess the transfer or the agreement and refund the duty paid after: (a) if duty was paid on the transfer of matrimonial property to the parties to a marriage or either of them, or to a child or children of either of them, and (b) the transfer was effected as referred to in s 68(1)(b), and (c) the marriage has been dissolved or annulled or has broken down irretrievably. Refunds are also available in respect of financial agreements entered into and stamp duty paid in respect of transfers of property between spouses prior to the amendments made by the State Revenue Legislation Further Amendments (No 2) Act 2001.

¶18-605 Principal place of residence There is an exemption from stamp duty under s 104B of the Duties Act in respect of a transfer by one spouse of one-half of their interest in a property to their spouse or de facto partner. The transfer must be such that the property will be held as joint tenants or as tenants in common in equal shares. In respect of de facto partners, the Duties Act provides that the parties must have been living together in a de facto relationship for not less than two years, otherwise the exemption is not allowed. The further pre-condition in relation to the exemption is that the property must be held as the principal place of residence of the parties after the transfer is effected. The exemption also extends to vacant land in circumstances where the married couple or de facto partners intend to use it as the site of a private dwelling house to be solely or principally used as their principal place of residence, as well as to the transfer of shares that confer an entitlement to exclusive possession of a company title dwelling that was solely or principally used as at the date of the transfer as the principal place of residence of the married couple or de facto partners. Care must be exercised when obtaining instructions from clients to effect the above transfer. While the stamp duty exemption will apply regardless of whether the property was used by the spouse as an investment or principal place of residence, as long as the property will be used by the parties as their principal place of residence then the exemption will apply. However, if the property had been used for investment purposes or not as the spouse’s principal place of residence, then CGT issues may arise. CGT is payable on the transfer of a half interest in a property from a partner to their spouse. The CGT rollover will not apply as s 126-5 of the ITAA97 applies on marriage breakdown.

LAND TAX AND FAMILY BREAKDOWN ¶18-610 Land tax and family breakdown The following applies to land tax in NSW. Land tax is a tax levied on the owners of land situated in NSW as at midnight on 31 December of each year. In general, a principal place of residence or land used for primary production (a farm) is exempt from land tax. However, land tax may be levied on: • vacant land, including vacant rural land • a holiday home • investment properties • company title units, or

• residential, commercial or industrial units. Land tax is calculated on the total value of all taxable land owned by a party above the land tax threshold. For 2019, the general threshold is $692,000 with the tax being $100 plus 1.6% of land value above the threshold up to the premium threshold. The premium threshold is $4,231,000 and land tax is payable at the rate of 2% above the premium threshold. Example If a party has land holdings with a total value of, say, $1,000,000 (excluding their principal place of residence), then the land tax payable in the 2019 tax year will be as follows: $1,000,000 − $692,000 = $308,000 × 1.6% = $5,936 plus $100 = $4,928

A company is assessed in the same way as a sole owner unless it is related to another company. A trustee of a trust is assessed in the same way as a sole owner unless it is a special trust. There is no threshold for non-concessional companies and special trusts. These entities will be taxed at the flat rate of 1.6% on the total value of all the taxable land owned. This includes hybrid trusts. Where land is owned by a trustee of a special trust, or is owned by a company classified under s 29 of the land tax legislation as a non-concessional company, the land tax threshold does not apply and land tax will be charged at a flat rate of 1.6% of the taxable value. From the 2009 tax year, a premium land tax marginal rate of 2% will apply if total taxable land value is above $4,231,000 (for 2019). It is important to consider the land tax implications of a property settlement as there is no land tax rollover on transfer of land pursuant to court orders. Thus, if a company is to transfer land to a spouse pursuant to a court order, then land tax may well be payable by the company and this needs to be considered at the time of settlement. Similarly, this also applies to the transfer of an investment property between spouses under a court order.

FAMILY TRUST ELECTIONS ¶18-615 Income and taxation opportunities in making a family trust election Generally, the trustee of a discretionary trust would consider making a family trust election in the following circumstances: • the discretionary trust has tax losses and would like to carry forward its losses. If the discretionary trust had made a family trust election, it only needs to satisfy the income injection test to enable the losses to be carried forward • the discretionary trust is the shareholder of a company that has tax losses and the company would like to carry forward the losses. If a family trust election is made, the discretionary trust is deemed to hold the shares in the company in the capacity of an individual. This will assist the company to satisfy the various tests which must be passed before it can carry forward its tax losses • the discretionary trust will be receiving franked dividends for shares that it acquired after 31 December 1997 and would like to pass on the franking credits that are attached to the dividends to its beneficiaries. Although the making of a family trust election will ensure that the relevant tax benefits can be passed on to the beneficiaries and related entities, the election has the effect of narrowing the class of beneficiaries to whom distributions from a discretionary trust can be made tax-effectively. This narrower class of beneficiaries (called the “family group”) is defined in the ITAA36 by reference to a “test individual”. Any income distributions made by the trustee to a beneficiary that is not within the “family group” will result in the trustee being liable to family trust distribution tax (FTDT). FTDT is charged at a rate equal to the top marginal rate plus the Medicare levy on the amount of income distributed to that beneficiary.

Section 272-95 of Sch 2F of the ITAA36 sets out the members of a “family group” as: “(a) any parent, grandparent, brother or sister of the test individual or the test individual’s spouse; (b) any nephew, niece or child of the test individual or the test individual’s spouse; (c) any lineal descendant of a nephew, niece or child referred to in paragraph (b); (d) the spouse of the test individual or of anyone who is a member of the test individual’s family because of paragraphs (a), (b) and (c)”. Section 272-90(2A) extends the family group further to include: “(a) a person who was a spouse of either the primary individual or of a member of the primary individual’s family before a breakdown in the marriage; and (b) a person who was a widow or widower (whichever is applicable) of either the primary individual or of a member of the primary individual’s family and who is now the spouse of a person who is not a member of the primary individual’s family; and (c) a person who was a step-child of either the primary individual or of a member of the primary individual’s family before a breakdown in the marriage of the primary individual or the member of the primary individual’s family”.

¶18-620 Income splitting during marriage or relationships and after separation During the course of marriage or relationships, parties generally split the income of partnerships, companies or trusts between spouses. There is nothing unusual in this. However, on separation, one of the spouses may retain control of the entity while the other spouse is shut out. As family law cases can take up to two years to be determined, it is important as an adviser who may be acting for both spouses to consider whether the splitting of income should continue during the separation period. For the spouse who has been shut out of the entity, this may not be an arrangement that would be in their interest as income tax would be payable on such splitting and they may not receive any of the income. On occasions where the controlling spouse is ordered by the court to pay spouse maintenance, they may pay that maintenance through income splitting, which again will trigger an income tax liability. The recipient spouse should ensure that if such an arrangement will or may likely be put in place by the controlling spouse, they are not liable to pay the tax or any penalties that may be levied by the ATO, if the ATO forms the view that such an arrangement falls foul of tax law, by obtaining indemnities from the controlling spouse. It is also important that at the time of making final orders indemnities be provided by the controlling spouse in relation to all taxes that may be payable as well as other indemnities, which will be outlined below. Such indemnities could prove valuable if the client later finds out that their spouse had made declarations of income which they never received. For example, in one case a spouse declared a trust distribution in favour of their former spouse on the eve of the making of court orders without informing the spouse. The indemnities that were included in the orders proved valuable as they assisted the spouse in forcing the other spouse to be liable for the tax payable on the distributions which were never received.

¶18-625 Indemnities and guarantees from the controlling spouse Generally, the exiting spouse must ensure that they obtain indemnities from the controlling spouse in relation to: • all claims made against the entity by a third party • any claims that the entity or the controlling spouse has against the exiting spouse of the entity • all tax liabilities including CGT, goods and services tax (GST), income tax and all other tax liabilities,

that may arise in respect of any act or thing done or omitted to be done by the exiting spouse, whether by reason of the exiting spouse having been an employee and/or director and/or officer of the entity and/or by reason of the exiting spouse’s shareholding within the entity and/or any loan account in the exiting spouse’s name and/or the receipt by the exiting spouse of any monies at any time from the entity or otherwise. It is also important to ensure that the exiting spouse is released from all guarantees they may have given during the period of the marriage. Omission to obtain such a release means that the client may be called upon to make good any default by the entity even years after the spouse exited the entity. While an indemnity may be obtained from the controlling spouse that they be responsible for and indemnify the exiting spouse in relation to all guarantees, this is not ideal and in some cases not sufficient. The exiting spouse should be released from the guarantees as part of the orders to ensure that they will never be called upon to make good any default.

MAINTENANCE ¶18-700 Spouse maintenance In cases where one spouse earns the income and the other attends to the homemaker and parenting role, after separation the party who did not work during the course of the marriage or relationship may apply for spouse maintenance. This is maintenance for the support of the spouse (not the children). Generally, a spouse would make an application for spouse maintenance shortly after separation. The court has to be satisfied that the spouse making the application has a need and that the financial activist spouse has the capacity to pay spouse maintenance. Need does not mean subsistent level but a reasonable standard based on the particular circumstances of the case. There may be cases where someone’s needs may be found to be $300 per week whereas in another case the party’s needs may be $10,000 per month. There is no hard and fast rule that the court applies as to the level of maintenance awarded. The interim spouse maintenance, if awarded, will continue until the final hearing where the court has to assess whether the spouse does still need the maintenance, taking into account the property settlement that the court will award that spouse. For instance, in a case where a spouse becomes entitled to $2m in property settlement, the court may take the view that the spouse would not have a need after receipt of the settlement and therefore until the settlement is effected, the spouse will continue to receive the maintenance. In doing so, the court has taken into account the spouse entitlement to spouse maintenance in the property award. There may be cases where the parties may not have significant assets but the financial activist spouse earns significant income. Take, for example, parties who have a modest pool of about $500,000 but the husband earns in excess of $500,000 pa. It would be open to the court in such a case to award spouse maintenance for a lengthy period of time, especially if the parties have young children and the wife has limited or no capacity to return to the workforce. Once the need threshold has been established, the court looks at the financial activist and examines whether they have the capacity to pay spouse maintenance. In doing so, the court looks at the wealth and income of the spouse from all sources, the history of support provided by the spouse and other factors. Once the court’s jurisdiction has been enlivened for spouse maintenance, the court is not confined to awarding periodic spouse maintenance but can award lump sum spouse maintenance. Lump sum may be awarded not only as a capitalisation of periodic spouse maintenance but because of the facts, justice and equity of the case. It may be possible for a spouse running their own business to structure the payment of interim spouse maintenance by causing the company to pay spouse maintenance and the company to meet the tax payable. While this is possible, it may be that such an arrangement (in circumstances where the spouse ceases to be involved in the business) runs foul of Pt IVA of the ITAA36.

¶18-705 Child maintenance and support

Child support is governed under the Child Support (Assessment) Act 1989. The Department of Human Services (the Department) administers the child support scheme. The scheme is an administrative process rather than a judicial body. The child support tables published yearly outline the level of child support to be paid by a payer. The level of child support payable varies depending on the number of nights a payer has the children in their care (ie stay overnight) and the income earned by the payer as well as the income earned by the payee. Children born after 1 October 1989 or if their parents separated after that date fall under the child support scheme set up under the Child Support (Assessment) Act 1989. Since 1 July 2009, same-sex couples who have separated and meet the new parentage definitions are able to apply for child support for eligible children from their relationship. Under the child support scheme: • the upper limit on income taken into account is 2.5 times all employees average weekly earning (EAWE). • child support payments are calculated based on the actual costs of children • the combined income of both parents is used to calculate child support payments, treating the incomes of both parents equally • both parties’ contributions to the cost of their children through care and contact is recognised • the proportion of child support that may be provided as non-agency payments is 30%, and • children of first and second families are treated more equally. The changes that commenced on 1 July 2006 included a reduction of the maximum amount of child support payable by high income earners to ensure these payments are better aligned with actual costs of children. The maximum combined adjusted child support income for the 2020 child support year is $191,815. The changes also take all of the payee’s income rather than the previous system which used a disregarded income figure of $45,505. The changes also treat more fairly income earned from second jobs and overtime that assists with re-establishment after separation. Since 1 July 2008, six new formulas apply to the calculation of child support. Ninety per cent of cases will fall under the basic formula (formula 1). The new child support formulas are premised on the costs of children and take into account both parents’ incomes after certain exclusion of a self-support amount (calculated as ⅓ of the Male Total Average Weekly Earnings indexed annually). The assessment will be affected after a child spends more than 14% of the time with the non-resident parent. The costs of children are ascertained by reference to the Costs of Children Table set out in s 55G of the Child Support (Assessment) Act 1989. Since 1 July 2008, parties have been able to enter into child support agreements. There are two types of agreements that can be entered into, namely, limited child support agreements (LCSA), and binding child support agreements (BCSA). For an agreement to be a LCSA, the following must apply: • be in writing and signed • can be made without legal advice • can only be made in relation to a child in respect of whom an administrative assessment can or has been made • can only be made between an eligible carer and a person who is a parent of the child and resident in Australia on the day the LCSA is entered into • has no effect unless it is accepted by the Child Support Registrar

• must comply with s 80E of the Child Support (Assessment) Act 1989 requirements — namely the amount of support to be paid must be at least equal to what the assessment provides for or would otherwise be payable under the formula • has a statutory sunset clause of three years after which either party can terminate the LCSA. For an agreement to be a BCSA, the following must apply: • must comply with the same formal requirements under a LCSA • must have legal advice and certificates as to legal advice annexed to the BCSA • does not have to comply with s 80E requirements — namely the payment payable could be less than an administrative assessment or would otherwise be payable under the formula. Parents can make an agreement to pay some or all of their child support using a lump sum without agreeing about the amount of child support — they can continue to have formula assessments each year. Example John and Joanne separate and decide that Joanne can retain the house on the basis that Joanne has to pay John $100,000. Instead of making that payment, John and Joanne agree to enter into a lump sum agreement for the $100,000. This sum will constitute a credit for John which will gradually be drawn down as John draws against it to meet his child support obligations. The remaining credit will be indexed at the end of each financial year. In the 2020/21 year, assume John’s liability is $20,000 per year in child support. At the end of 2020/21, John’s child support liability is met from the lump sum credit. Assume the agreement is entered into on 1 October 2020. The credit used up for the remaining 270 days is $14,785. The remaining credit is $85,215. This is indexed by the CPI. If the relevant factor for 2020/21 is 1%, then the indexed amount is $86,067.

Binding Child Support Agreements After separation, parties can enter into a Limited Child Support Agreement or a Binding Child Support Agreement. A Limited Child Support Agreement is one that can only be for a maximum of three years in duration and does not require the parties to have a lawyer give independent legal advice about the Agreement. A Binding Child Support Agreement requires lawyers to provide independent legal advice about the agreement into which the parties enter. A Limited or a Binding Agreement can deal with periodic or non-periodic child support, or both. The effect of entering into such an agreement is that the subject matter of the agreement ousts the child support agency (part of the Department of Human Services) from dealing with matters the subject of the agreement. A Binding Child Support Agreement is difficult to set aside. A Binding Child Support Agreement can only be set aside upon application to the Family Court or by consent. Assuming there is no consent, the applicant must establish that there are exceptional circumstances to warrant the agreement being set aside. In Telama & Telama (No 2) [2017] FamCAFC 194, the parties entered into a Binding Child Support Agreement in 2010. That agreement was terminated by consent in 2013 and replaced by a new Binding Child Support Agreement. At the time of entering into the 2013 agreement the father’s income was $710,000. The Agreement provided for the father to pay to the mother by way of periodic child support the sum of $6,815.33 per month plus other non-periodic expenses. The effect of the Agreement was that the father was to pay approximately $140,000 per annum in total child support for the parties’ four (4) children. After 2013 the father lost his job and his income reduced to $220,000 per annum. The father stopped paying child support so the mother commenced proceedings to have the Agreement enforced. By way of response the father sought to have the Agreement set aside. At first instance the Agreement was set aside with the trial judge finding that the father’s income was insufficient to pay all of his obligations under

the Agreement. The mother appealed the Orders on the basis that the father had not given any evidence or disclosure of his financial position. The Full Court allowed the appeal and remitted the matter for rehearing. In doing so the Full Court noted that “the point of a binding child support agreement … is that it provides certainty for the parties as to the amount payable … they cannot be varied and may only be terminated in limited ways, and as such it is obvious ‘that each party to such an agreement takes a risk that the certainty they gain by entering into such agreement is balanced against the difficulties in changing it’”. When one parent lives overseas Australia’s international maintenance arrangements apply when one parent lives in Australia and the other parent lives in a country that is a reciprocating jurisdiction. The principle of these arrangements is that, wherever possible, a liability should be issued and administered in the jurisdiction where the payee resides. The jurisdiction in which the payer is resident is responsible for collection and providing the payer with reasonable assistance in dealing with the overseas authority. A payee in Australia can apply for a child support assessment if the payer is a resident of a reciprocating jurisdiction on the day they make the application, except if it is one of the excluded jurisdictions. A payee must obtain a court order for child maintenance if the payer resides in an excluded jurisdiction. An overseas authority can apply for a child support assessment on behalf of a liable parent resident in their jurisdiction. A liable parent who is resident overseas cannot make their own application for an administrative assessment. A payee in a reciprocating jurisdiction can apply for a child support assessment for a child who does not meet the usual residence requirements (the child is in Australia when the person makes the application; and the child is an Australian citizen, or ordinarily resident in Australia on that day). An overseas authority can also apply on behalf of a payee resident in their jurisdiction. A payer in Australia cannot apply for a child support assessment payable for a child who does not meet the residence requirements. Centrelink benefits If the payee is in receipt of a Centrelink benefit, they must make an application through Centrelink and they cannot opt out of the child support scheme nor can they negotiate a payment of child support that is less than what they would be entitled to receive under an assessment. If the payee is not in receipt of a Centrelink benefit, they are at liberty to negotiate a child support agreement with the liable parent. Such an agreement can only be enforced by the payee after they have registered the agreement with the Department, and the Department accepted the agreement in writing. An agreement that has not been accepted by the Department means that the agreement cannot be enforced in the court. The agreement may be enforced as a contract; however, this is far from ideal. Prescribed payments are certain payments that can be credited as child support even if the parent receiving child support does not agree the payment was in lieu of child support. As long as the paying parent pays 70% of their normal monthly child support payment on time, a maximum of 30% of the monthly payment can be credited in this way. Prescribed payments can be for childcare costs, school fees, school uniform and book fees, essential medical and dental items, the other parent’s share of rent, mortgage, utilities and rates, or some motor vehicle costs. The Department, however, will only credit prescribed payments if the paying parent has less than 14% (regular) care for all the children of the assessment. This is because if the paying parent has more than 14% care of any of the children, the direct costs that parent incurs when caring for the children are recognised in the child support formula. The child support scheme works and will work well with payers who are employees who are the subject of Pay As You Go (PAYG) income tax. Where payers are contractors or owners of private companies or those people who have the potential to distort their true income position, the child support scheme may not deliver justice to the payee, although parties are entitled to apply to review the child support assessment. If either party is not happy with the assessment issued by the Department, they can apply to review the assessment. Lawyers are not allowed to represent clients; however, they can assist them in completing the form. The parties need not attend the hearing personally. They can do so by telephone and not at the same time as the other parent.

Reviewing the child support assessment There are a number of reasons why a parent currently may seek a change to the assessment; however, the officer has to be satisfied that in the special circumstances of the case, one of the following main reasons are made out: • It costs more than 5% of the payee’s adjusted taxable income to spend time with or communicate with the child/children. • It costs the payee extra to cover the children’s special needs. • It costs extra to care for, educate or train the children in the way that the parents intended. This may result in the payer being asked to pay in addition to the periodic child support amount, the children’s school fees and for extracurricular activities or part thereof. • The child support assessment does not take into account the income, earning capacity, property or financial resources of the children. • The child support assessment does not take into account the income, earning capacity, property or financial resources of one or both parents. If a parent is unhappy with an assessment issued by the agency, they can lodge an objection which will be determined by the registrar. If either parent is unhappy with the Department’s decision, the parent can make an application to review the assessment on any of the grounds referred to above. If either party is still dissatisfied with the result, they will have to apply to the Administrative Appeals Tribunal (AAT). Parties can have legal representation at the AAT. A decision from the AAT can be appealed to the court but only on questions of law. The road to the court is a long one and the new process is aimed at trying to ensure that child support matters are dealt with efficiently. It is still possible to bypass the various steps above and proceed to court if there is a financial matter that the court is dealing with at the same time. A current child support year runs for 15 months; however, a new assessment is issued when a tax return is lodged by either party. The current child support payable by a payer will be reduced if the payer has the children for more than 109 nights. The new scheme is different in that there are no threshold number of nights before there is a reduction in child support payable. The new formula takes into account the number of nights the child or children stay with each parent. While negative gearing has the effect of reducing one’s taxable income, for child support assessment purposes, the Department will ignore negative gearing in calculating the payer’s child support liability. The income a partner of either the payee or the payer receives does not affect the assessment. The payer’s liability for child support will not be calculated on the basis of overtime work done by the payer to support their new family.

¶18-710 Adult child maintenance There are limited circumstances where parents may be obliged to continue to support their adult children. Generally, this occurs where a child has a disability or where a child is undertaking tertiary studies and therefore is unable to support themselves. The level of adult child maintenance payable will depend on the standard of living of the parties and children, the income of the parents and the children’s needs. The court apportions the amount payable by the parents to reflect the parents’ capacity to support the adult child.

¶18-715 Child maintenance trusts A child maintenance trust is a trust that arises as a result of the family breakdown. As the name suggests, it is a trust which is set up to receive child maintenance payments. One of the principal benefits of a child maintenance trust is that it enables tax-effective income splitting to

beneficiaries of a trust (including beneficiaries who are under 18 years of age) without attracting the penalty tax provisions contained in Div 6AA of the ITAA36. Minor beneficiaries can only receive tax-free distributions of trust income up to $416. Any amount received by minor beneficiaries above this sum will be taxed. Specifically excluded from these penalty provisions is income received by minor beneficiaries of a child maintenance trust. Under the tax rules applying to child maintenance trusts, minor beneficiaries are given the benefits of ordinary tax treatment. That is, each minor beneficiary of a child maintenance trust will enjoy a tax-free threshold of $18,200 and the usual marginal tax rates applying to income distributions from the child maintenance trust in excess of $18,200. By recognising the circumstances where a child maintenance trust can be used, considerable amounts of after-tax dollars can be saved. But there are also benefits to the person making the child maintenance payments. Ordinarily, child maintenance or child support payments are made from after-tax dollars, that is, from the pool of money on which tax has already been paid. A properly structured child maintenance trust can enable child maintenance payments to be effectively paid out of pre-tax dollars. Example Robert has recently been separated from his wife Janet. The children, Daniel aged six years and Alyssa aged four years, live with Janet but spend five nights per fortnight with Robert. In accordance with the child support tables, Robert must pay $30,000 pa to Janet for the benefit of Daniel and Alyssa. Robert currently earns $215,000 as an accountant, and $35,000 as income from an investment vehicle. His tax (including Medicare levy of 2%) will be $90,731 with an after-tax income of $159,262. As a result of his $30,000 child support obligations, Robert is left with $129,262. Robert’s after-tax and “after-child support” income position could be improved by the effective utilisation of a child maintenance trust. Robert could transfer property (for example, an interest in an investment vehicle, cash, income-generating shares or incomegenerating property) to a child maintenance trust for the benefit of the children. The property transferred to the child maintenance trust is invested to generate income and, as trustee of the child maintenance trust, Robert can direct that $30,000 per year be distributed to Daniel and Alyssa (ie $15,000 to each). If the income generated in the child maintenance trust was $35,000 per year, the balance of the income ($5,000) could be distributed to Robert. What is Robert’s income position now? His income is $220,000 (salary of $215,000 and child maintenance trust income of $5,000). His tax liability (including Medicare levy) is $76,631, leaving an after-tax and after-child maintenance income of $143,369. What is Robert’s child support obligation? It is still the same, ie $30,000. Only now it has been paid from the child maintenance trust. Robert has been able to improve his after-tax position and his after-child support position by $14,100 per year by utilising a child maintenance trust. Robert will make child support savings of at least $14,100 each year for the next 11 years (assuming the tax rates remain the same) (until the eldest child reaches 18 years of age) with further savings being made in years 12 and 13 (ie until the youngest child reaches 18 years of age).

Factors to consider There are a number of important factors to consider in the establishment of a child maintenance trust arrangement including the following: • the terms of the child maintenance trust must comply with the prevailing tax laws (see s 102AG(2)(c) (viii) and s 102AGA of ITAA36) — principally, the trust must have arisen as a result of a family breakdown and the children must acquire trust property on vesting day • the child maintenance trust arrangements must be consistent with existing child support obligations • the transfer of property to the child maintenance trust to generate income may give rise to capital gains tax and stamp duty implications depending on the nature, cost and value of the property transferred.

OTHER ISSUES ¶18-800 Full and frank disclosure of financial position

The Family Law Act and the Family Law Rules 2004 provide that each party must make full and frank disclosure of their financial position. The Rules provide that Pre-Action Procedures (PAP) must be attended to before parties file for property settlement and parenting issues (however, there are exceptions such as property at risk of dissipation). The PAPs are aimed at ensuring litigation is a last resort. If the matter does not settle, a party may then wish to apply to the court for property settlement. There are two court phases, namely the resolution phase and the determination phase. In the resolution phase, there are two court events, namely a case assessment conference and a conciliation conference. If the matter does not settle at the conciliation conference, the matter then moves to the determination phase where the court makes directions for the preparation of the matter for trial and the appointment of single experts to prepare valuation of the property in dispute. As part of the PAP and full and frank disclosure, parties must exchange financial documents and keep each other informed of changes in their financial position throughout the negotiations and until orders are made. The parties’ duty of disclosure is broad and very extensive so as to ensure that each of the parties and the court are fully informed of the parties’ financial position before a decision is made about dividing the pool. It is very crucial for clients to comply with their duty. Once a finding has been made by the court that a party did not make a full and frank disclosure of their financial position, then the court would not be unduly cautious about making findings in favour of the innocent party. To do otherwise might be thought to provide a charter for fraud in proceedings of this nature. Advisers are in a good position to assist in this area, as they have a good understanding of the client’s financial affairs.

¶18-805 Issuing or receiving a subpoena Parties are entitled to cause to be issued by the court a subpoena to produce documents. A subpoena is directed generally to a third party to produce documents in that third party’s possession, custody or control. Advisers may be served with a subpoena. It is important to note the following about a subpoena: • a subpoena is a court order and must not be ignored • if a subpoena is not complied with, the party at whose request the subpoena was issued can apply to the court for the arrest of the person named in the subpoena for failure to comply with the subpoena • a subpoena must give the recipient at least 10 days after it is served to produce the documents • a subpoena must be accompanied with conduct money. Generally, $25 is paid at time of service. This is not the complete conduct money in compliance with the subpoena. A subpoena recipient can ask for money that they will incur in complying with the subpoena, such as time in compiling the documents, photocopying and the like • a subpoena recipient cannot withhold production of documents on the basis that proper costs of the recipients have not been paid. If the conduct money is not sufficient to comply with the subpoena, negotiations should be entered into with the party on whose behalf the subpoena is issued and if there is no agreement, an application for costs be made by the recipient to the court • once served with a subpoena, the adviser should immediately provide a copy of it to their client as their client may wish to object to the subpoena or certain parts of it. (While the Rules provide that the party at whose request a subpoena is issued must provide a copy of the subpoena to the other party at least seven days prior to the return date of the subpoena, this may not occur and this may be the crucial time that the client requires to consider their legal position in relation to the subpoena issued.)

¶18-810 Family Court’s powers over business entities

Where a company is owned by the parties, in all likelihood the court will find that the company is the alter ego of a spouse or both of them. The Family Court has wide powers against the company (or trust for that matter). The court can bind the company through the spouse as the company is the spouse’s alter ego. Where third parties are involved, the court’s powers are not unfettered. The High Court in Ascot Investments Pty Ltd v Harper and Harper (1981) 148 CLR 337 found with respect to Family Court jurisdiction of third parties as follows: • an order cannot be made where its effect will be to deprive third parties of an existing right • an order cannot be made to impose on such a party a duty which the party would not otherwise be liable to perform • parliament did not intend for third party interests to be subordinated to interests of parties through a marriage • parliament did not intend that the court should be able to make an order that would operate to the detriment of third parties. The court’s ability to deal with family companies involving third party interests have been developed by the High Court and the Family Court, enabling the Family Court: • to set aside transactions pursuant to s 106B of the Family Law Act • to make orders directly in relation to property in ante-nuptial or post-nuptial settlements made in relation to the matter pursuant to s 85A of the Act • if there are other ample assets for distribution between the parties, to establish that the party has a financial resource represented by the third party’s property • to find that the third party is the alter ego of a party to the proceedings • to find that the third party is a sham brought into being in appearance rather than reality as a device to assist one party to evade their obligations under the Act • to find that the third party is the puppet of a party to the marriage (eg the company is completely controlled by one party to a marriage) so in reality an order against the company is an order against the party • to grant injunctive relief • to make orders against the third party if the third party is in effect an accomplice of a party to a marriage whose actions are designed to assist one spouse to the disadvantage of the other • to make a declaration pursuant to s 78 of the Act that the spouse be declared the equitable owner of certain property held by the company. As can be gleaned from the above, the Family Court still has wide powers in relation to companies, including companies where third parties are involved. One of the difficulties that the Family Court grapples with is the valuation of family companies. Such companies may be valued in a number of ways with significant differences in value. Some of the valuation methodologies that the court has accepted depending on the facts of each case include future maintainable earnings, net assets, and value to the owner of super profits. This last valuation method causes the greatest grief as a company is valued on the basis of what it is worth to the owner after taking into account a reasonable salary for the owner. This valuation method has no correlation to the reality of what the company would be sold for to a third party purchaser who is a willing but not an anxious purchaser, by a seller who is not an anxious seller. Faced with such a valuation method, many clients now seek orders from the court for the sale of the

company if the valuation by a single expert is found to be above a certain amount as that spouse can no longer keep the business and pay out their former spouse their entitlement. This will no doubt have a follow-on effect in relation to that spouse’s future earning capacity and the adjustments that will ultimately be made by the court under the s 75(2) factors.

¶18-815 Third parties standing in the Family Court A party that may be affected by a decision of the court has standing to intervene in Family Court proceedings. Generally, family law proceedings are inter partes; however, there may be occasions where third parties need to intervene to protect their position. One example of third parties wishing to be involved in proceedings and even to commence proceedings is in the area of financial agreements. Third party proceedings can apply to set aside binding financial agreements (BFAs). The federal government had been concerned that the Act could be used to defeat or defraud creditors and those concerns have been addressed with amendments passed. “Third party proceedings” is defined to mean proceedings between: • either or both of the parties to a financial agreement, and • a creditor or a government body acting in the interest of a creditor, being proceedings for the setting aside of the financial agreement on the grounds specified in s 90K(1) (AA). Section 90K(1)(AA) provides that a financial agreement could be set aside by a court “if the agreement was entered for the purpose or purposes that included the purpose, of defrauding or defeating a creditor or creditors of the party or with reckless disregard of the interests of a creditor or creditors of the party”. A creditor in relation to a party to a financial agreement includes a person who could reasonably have been foreseen by the party as being reasonably likely to become a creditor of the party. A “government body” means the Commonwealth, a state or a territory or an official or authority of the Commonwealth, a state or a territory. The amendments to the Act are retrospective, that is they catch all financial agreements whether or not they were entered into before or after 5 December 2003. The amendments allow government instrumentalities such as the Australian Securities and Investments Commission (ASIC) to commence proceedings to set aside financial agreements. It is becoming increasingly common for third parties to be joined to family law proceedings. The third parties joined have generally been the parents of one of the spouses or a trust or company of the spouses’ parents. In addition, there has been a consistent attack by way of subpoena and discovery sought against trusts and companies of the parents of spouses in family law proceedings. It appears that the case of Kennon & Spry [2008] HCA 56 may have spurred some lawyers to seek financial documents from trusts. In recent cases such as McDowell and Williams [2012] FamCA 479 and the case of Keech and Keach [2011] FamCA 192, in determining whether financial statements should be the subject of a subpoena, judges have looked at effective control of and benefits received from trusts. This is achieved by examining whether the spouse has received trust distributions; whether the spouse is or has been a director of the trustee company (or is a trustee or co-trustee in their personal capacity) in determining the level of documentation to be provided. It is submitted that where a spouse has not received trust distributions and they are not and have never been directors of the trustee company and are not controllers of the trust then there is no apparent relevance to the financial statements being provided and disclosed. If a spouse never received a benefit from a trust, it would be hard to argue that there is a value to the interest in a trust where the interest is that of a beneficiary. Advisors who act for third parties ought to be aware of the grounds for objecting to subpoena issued to them for their client’s records. The recipient to the subpoena is entitled to object to a subpoena issued to them (this is over and above the standing that the parties to the family law proceedings have to object to subpoena). In the case of Kelton & Brady and Anor [2017] FamCAFC 186, the husband issued a subpoena to the accountant for the C Investment Trust being a discretionary trust controlled by the wife’s mother. The husband sought the production of the financial accounts of the trust. Both the wife and her mother

provided evidence that the wife never received any distribution from the trust and had no beneficiary loan account. The husband did not accept this evidence. The accountant objected to the production of the documents sought by the husband on the basis that there was no relevance to the documents sought to the proceedings between the husband and the wife. As the objector the accountant for the C Investment Trust had the onus of establishing lack of apparent relevance which the accountant did in that case. The objection was upheld on review. The husband sought leave to appeal the decision. The Full Court dismissed the husband’s appeal finding that there was no error made by the primary judge. The Full Court also found that there was no evidentiary foundation for asserting that there was a lack of truthfulness in the evidence provided by the wife and her mother. While it is true that a beneficiary of a trust has the right to be considered for trust distributions and can insist on the proper administration of the trust and that this right is one that is a chose in action, it is submitted that the value of the same is very little if anything where the trust has never made distributions to the particular beneficiary.

¶18-820 When one of the spouses is bankrupt The Bankruptcy and Family Law Legislation Amendment Act 2005 extended the Family Law Courts jurisdiction to determine financial matters (property and spouse matters) where one of the spouses becomes bankrupt. The court can alter the rights of the trustee in bankruptcy in relation to the bankrupt’s property that has vested in the trustee in bankruptcy. In doing so, and after the court determines the pool of property that has vested by applying the equitable and bankruptcy principles, the court will apply the Family Law Act to determine the non-bankrupt spouse’s interest in the vested property based on the contributions and s 75(2) (or s 90SF(3) in de facto matters) factors referred to earlier in the chapter. The way the amendments the have been drafted leads to the conclusion that the court will notionally divide the gross value of the vested property between the non-bankrupt spouse and the trustee in bankruptcy and then apply s 75(2) (or s 90SF(3) in de facto matters). Subsection, s 75(2)(ha) (s 90SF(3)(i) in de facto matters), provides that before making any orders in respect of vested property, the court has to consider: “the effect of any proposed order on the ability of a creditor of a party to recover the creditor’s debt, so far as that effect is relevant”. This subsection is important as s 79(1) (s 90SM in de facto matters) does not provide that the Family Court must, in altering the parties’ interest, give all of the bankrupt’s assets which have vested in the trustee to the trustee to distribute amongst the creditors. On the contrary, in relation to vested bankruptcy property, the court under s 79(1)(b) (s 90SM(1)(b) in de facto matters) has the discretion to alter the interests of the “bankruptcy trustee in the vested bankruptcy property”. In doing so, no doubt the court will be concerned with the non-bankrupt’s contributions and the s 75(2) (s 90SF(3) in de facto matters) factors and it is when the court examines s 75(2)(ha) (s 90SF(3)(i) in de facto matters) that the court will look at the interests of creditors and balance them against the family. The subsection does not give the trustee or the non-bankrupt spouse any priority. The playing field is level and in assessing the many s 75(2) (s 90SF(3) in de facto matters) factors, one of the factors the court will look at will be s 75(2)(ha) (s 90SF(3) (i) in de facto matters).

¶18-825 Binding financial agreements Binding Financial Agreements provide a good measure of asset protection on marriage or relationship breakdown because they provide certainty of result on division of assets rather than rely on lawyers and judges to come up with a result that will cost tens of thousands of dollars. They are similar to “pre-nuptial” agreements as they are known in the United States but they are better than pre-nuptial agreements as BFAs can be entered into prior to the marriage, after the marriage, or after separation or divorce. Are BFAs for everyone? The short answer is, it depends. If the client has significant wealth whereas their future spouse has no or modest wealth, then it would be in their interest to enter into a financial agreement. As an adviser, you have an obligation to ask the client to consider entering into an agreement with their future spouse. This is not to say that they will rip off their future partner if they enter into a BFA as the BFA would outline each of the parties’ rights as to property division in the event of marriage breakdown. A client may own a farm that has been in the family for generations; the client may be in business with third parties or there is a prospect that they may receive a large inheritance in the future. This would be a good reason why a BFA would be beneficial. A BFA provides certainty of outcome in the event of separation. That is, by entering into the BFA the result of the property division is agreed upon and there is no question or argument. The Family Court’s jurisdiction is ousted and therefore the lawyers are ousted as well! Lawyers are required to provide a certificate confirming that they have provided advice on the agreement before the agreement can be valid. Each party must have their own independent lawyer. Can BFAs be abused? It was never envisaged that parties could enter into BFAs in order to reduce assets and remove them from claims by third parties such as creditors. Some people have tried that in the past but ultimately the government closed that loophole and now creditors or trustees in bankruptcy can apply to the Family Court to set aside a BFA if it can be shown that the BFA was entered into with a view to defeat or defraud creditors. A BFA can be used for a good measure of asset protection; however, planning when a BFA should be entered into and what it should provide for becomes crucial to ensure it will withstand attack from a future spouse, a creditor or future creditor or trustee in bankruptcy. More and more lawyers are no longer prepared to draft financial agreements because of the risk of being found negligent in the way the agreement is drafted. There have been a number of cases following the introduction of BFAs into the Family Law Act where BFAs were set aside because the lawyers did not comply with s 90G requirements. That appears to have been rectified by the government introducing rectification provisions which enables a judge to rectify any technical defects, however, the judge still has the discretion to set aside the agreement notwithstanding the power to rectify. More recently cases to set aside BFAs have centred on the substance of the agreement, namely whether the drafting was plain and covers the situation the parties find themselves upon separation. It appears that parties sometimes forget about their agreements once they are signed. In one case where the BFA was set aside, the parties set up a trust to run a business. Setting up a trust was never contemplated in the agreement and therefore no one could work out what each of them was entitled to. As a result, the BFA was set aside. In other cases, while parties may take into account contingencies such as the birth of children, if they do not specifically provide that regardless of whether they do or do not have children they want the same financial outcome to flow to the other spouse, the BFA is susceptible to being set aside. Care must be exercised when drafting BFAs. They are not standard documents. They need to be tailor made to suit the client’s needs and as such caution must be exercised when drafting. The adviser’s role in assisting with the drafting of a BFA cannot be underestimated. Their job complements that of the lawyer drafting as they understand the client’s financial needs and depths and what structures will be put in place in the future. A BFA that complies with s 90G requirements may still be set aside if the conduct of the parties in

entering into the BFA is found to be unconscionable or a party engaged in duress as was the case in the High Court of Australia decision in Thorne v Kennedy [2017] HCA 49; (2017) FLC 93-807. In that case, the wife, Thorne, a 36-year-old woman from Greece met Kennedy a 67-year-old man from Australia through a bride website in 2006. Thorne had no assets of significance and spoke very little English. Thorne had no children. Kennedy was a property developer. Kennedy had assets of around $18m. Kennedy was divorced from his first wife with whom he had three children who were all adults. The parties’ online romance blossomed with Kennedy promising Thorne a life of luxury in Australia. In February 2007 Thorne moved to Australia into Kennedy’s penthouse. The parties were set to get married on 30 September 2007. Ten days before their wedding, Kennedy took Thorne to see a solicitor, informing her that she was going to sign an agreement. Kennedy informed Thorne that if she did not sign the agreement the wedding would not go ahead. Being 10 days before their wedding Thorne’s family including her parents and sister had already arrived in Australia for the parties upcoming nuptials. Despite advice to her, both orally and in writing, advising against the agreement, Thorne signed the agreement proposed by Kennedy four days before their wedding. That agreement provided for Thorne to receive a total payment of $50,000 plus CPI in the event of separation only if the parties were married for at least three years. In the event of Kennedy’s death, the agreement provided for Thorne to receive an apartment worth up to $1.5m, a vehicle and an income. The agreements also provided that the parties would, within 30 days sign another agreement in similar terms (that being a BFA entered into after marriage). After their wedding and in November 2007 Thorne signed, again against legal advice, a further BFA in the same terms. During her meeting with her lawyer Thorne received a call from Kennedy asking her how long she would be. The impression of her lawyer was that Thorne was being pressured to sign the agreement which she did. Almost four years later the parties separated and Thorne commenced proceedings in the Federal Circuit Court of Australia where she sought Orders that the two agreements be set aside or declared as nonbinding. Kennedy died during the proceedings and his estate was substituted for him. At first instance the agreements were set aside with Judge Demack finding that Thorne signed the agreements under duress resulting from the “inequality of bargaining power where there was no outcome for her that was fair and reasonable”. Kennedy’s estate appealed the matter. The Full Court of the Family Court upheld the appeal finding that the agreements were binding and the Thorne was not under duress nor was there any undue influence or unconscionable conduct on the part of Kennedy. Thorne was granted special leave to appeal to the High Court on the basis that the agreements should be set aside for duress, undue influence or unconscionable conduct. The High Court held that the decision of Judge Demack should stand noting that the agreements were voidable for undue influence and unconscionable conduct.

¶18-830 Estate planning for blended families If the adviser’s client has children from a previous relationship or marriage, the adviser should advise the client to consider the impact of their superannuation death benefits as well as the structure of purchasing assets. For instance, if the client and their new spouse have just purchased a property in joint names or are intending to purchase a property in joint names then notwithstanding what the client provides for in their will, on their death their interest in the property will be given to their spouse by survivorship. If the client nominates that their superannuation death benefits be given to their current spouse, the adviser should ask the client to consider the impact of such a nomination on their children from their first marriage. Let us assume that the client separated from their spouse some time ago and has just met someone new. The client informs you, or you are aware that they have not yet done a property settlement with their former spouse; however, they are anxious to settle financially with their former spouse because they want peace and harmony in the new relationship. The client may inform the adviser that they have reached a settlement with their former spouse and wishes to give effect to that informal settlement. Advisers should direct the client to consult with a lawyer in order to document the agreement reached, as the former spouse could spend the money received in the informal settlement and then consequently

apply to the court for property settlement seeking a further division of whatever assets they have together with whatever assets the client has at the date of hearing, which may be months or even years after the informal agreement was effected. The court has in the past made fresh property settlement orders in favour of former spouses who received their full entitlement when the first unenforceable agreement was entered into and required one spouse to pay the other further monies. This would be in addition to the significant legal costs that the client would incur. The adviser should advise the client not to hand the money until the agreement is signed, sealed and delivered.

¶18-835 Alternate Dispute Resolution As discussed at ¶18-800, the Family Law Rules require parties to attend Pre-Action Procedures before proceedings are commenced. Often, this would include informal settlement conferences and mediation. This is an opportunity for advisers to seize upon and be involved in the settlement of their client’s family law disputes. This would be done in conjunction with the family lawyers retained by the client(s). The adviser’s role in the negotiations and structuring of settlements at mediation sessions could save the parties a significant amount in legal fees and in tax costs. Now, more than ever, lawyers and advisers need to communicate and collaborate to deliver wholesome and complete advice to their clients. In April 2020, the Chief Justice of the Family Court of Australia announced the appointment of a list judge in each court to hear and manage application and directions for cases that have been referred to arbitration in response to the expected delays to be felt in the wake of COVID-19. Arbitration can only be done with the consent of all parties. It is expected that there will be growth in this area of dispute resolution as the delays increase.

ESTATE PLANNING AND THE CONSEQUENCES OF DEATH The big picture

¶19-000

Estate planning Importance of estate planning

¶19-010

What forms part of an estate?

¶19-020

Wills The will

¶19-030

Estate planning objectives

¶19-035

Ownership of assets

¶19-040

Legal requirements for will preparation

¶19-045

Intestacy

¶19-047

Executors

¶19-050

Appointment of guardians

¶19-055

Gifts to beneficiaries

¶19-060

Distribution of personal chattels

¶19-065

Fixed life interest

¶19-070

Discretionary life interest

¶19-075

Special requests contained in a will

¶19-080

Reviewing and updating a will

¶19-085

Contesting a will

¶19-090

Family provision

¶19-095

Probate

¶19-100

Account-based pensions or annuities

¶19-110

Adjusting beneficiary entitlements

¶19-115

Capital gains tax and deceased estates Death not a disposal

¶19-150

Main residence exemption

¶19-155

Gifts to tax-exempt organisations

¶19-160

Testamentary trusts

¶19-165

Discretionary will trusts What is a discretionary will trust?

¶19-200

Who controls a discretionary will trust?

¶19-205

Beneficiaries of a discretionary will trust

¶19-215

Establishment of more than one trust

¶19-225

Planning opportunities of discretionary will trusts Planning opportunities of discretionary will trusts

¶19-250

Income tax savings

¶19-255

Protection from insolvency and other liabilities

¶19-260

Capital gains tax opportunities

¶19-265

Family law protection

¶19-270

Trusts and Age Pension entitlements

¶19-275

Restricted trusts What is a restricted trust?

¶19-300

Control of restricted trust

¶19-305

Application of trust fund

¶19-310

Death of restricted trust beneficiary

¶19-315

Non-estate assets Non-estate assets

¶19-350

Jointly owned assets

¶19-355

Assets of discretionary trusts

¶19-360

Superannuation proceeds

¶19-365

Life insurance

¶19-370

Further planning opportunities Taking advantage of the rules for minors

¶19-400

Superannuation proceeds trust

¶19-405

Estate proceeds trust

¶19-410

Powers of attorney Powers of attorney

¶19-450

Types of powers of attorney

¶19-455

Scope of attorney’s authority

¶19-460

Legal requirements for power of attorney

¶19-465

Multiple attorneys

¶19-470

Revocation of power of attorney

¶19-475

Consequences of death What forms part of a person’s estate

¶19-500

Where there is a will

¶19-505

Duties and powers of executor/trustee

¶19-510

Where there is no will

¶19-515

Where a will is contested

¶19-520

Distributing the assets

General tax rules that apply to the distribution of assets ¶19-550 Tax on disposals of estate assets

¶19-555

Tax rules that apply to different types of estate assets Tax rules for different types of estate assets

¶19-600

Estate asset: dwellings

¶19-605

Estate asset: superannuation

¶19-610

Estate asset: life insurance

¶19-615

Estate asset: shares

¶19-620

Estate asset: accrued leave payments

¶19-625

Estate asset: personal use assets and collectables

¶19-630

Estate asset: motor vehicles

¶19-635

Rules that apply to different types of entitlements under wills Different types of entitlements under wills

¶19-650

Legacies

¶19-655

Contingent gifts

¶19-660

Annuities

¶19-665

Assets appropriated by trustee for beneficiary

¶19-670

Assets subsequently acquired by trustee

¶19-675

Asset sold to beneficiary

¶19-680

Asset acquired under an option

¶19-685

Asset that has been “improved”

¶19-690

Assets previously held by joint tenants

¶19-695

Entitlement under discretionary trust

¶19-700

Property subject to a mortgage

¶19-705

Life estates

¶19-710

Disclaimed interests

¶19-715

Rules that apply to different types of beneficiaries Children as beneficiaries

¶19-750

Charities and superannuation funds

¶19-755

Public galleries, museums and libraries

¶19-760

Non-resident beneficiaries

¶19-765

How death affects a person’s business Effect on business succession

¶19-800

Effect of death on trading stock

¶19-805

Effect of death on depreciable assets

¶19-810

Estate income and testamentary trusts Estate income and testamentary trusts

¶19-850

Tax rates on trust income

¶19-855

What tax returns are needed Date-of-death or “terminal” tax return

¶19-900

Estate returns for period after death

¶19-905

Timing issues for date of death vs estate return

¶19-910

How death affects other taxes and benefits Death and liability for duties

¶19-950

Death and liability for land tax

¶19-955

Death and social security

¶19-960

¶19-000 Estate planning and the consequences of death

The big picture Purpose of chapter The purpose of this chapter is to provide a practical introduction to the essential features of estate planning and estate administration. The following matters are discussed: • The basic requirements for the preparation of a valid will. • An explanation of testamentary trusts, their uses and benefits. • Dealing with “non-estate” assets such as superannuation, life insurance and assets owned by discretionary trusts. • Other planning opportunities that should be considered as part of the estate planning process. • Taxation considerations relating to deceased estates. • The treatment of assets upon death. • Distribution of assets where there is a will and where there is no will. • Treatment of different types of beneficiaries. The chapter is divided into two sections: • Estate planning (¶19-010 to ¶19-475). • Consequences of death (¶19-500 to ¶19-960). Estate planning Estate planning refers to the process of planning and documenting wishes for the distribution of all assets owned and controlled at death. The preparation of a will is an essential part of the estate planning process. • A will deals only with those assets owned personally by a willmaker. Such assets are referred to as “estate assets”. Other assets may be controlled rather than owned by a willmaker. Such assets include jointly owned assets, assets owned by a trust, and superannuation fund assets. These assets are referred to as “non-estate assets” .................................... ¶19-020 • It is essential to distinguish between estate and non-estate assets early on in the estate planning

process. Additional planning is required beyond the will to deal with the succession of non-estate assets .................................... ¶19-350 • Thorough estate planning should take into account the preparation of testamentary trusts through a will. A testamentary trust is a trust established by a will that comes into effect upon the death of a willmaker. The most common form of testamentary trust is the discretionary will trust .................................... ¶19-165 • A discretionary will trust describes a form of ownership of assets whereby a trustee holds assets on trust for the benefit of one or more beneficiaries .................................... ¶19-200 • A discretionary will trust provides the beneficiaries of an estate with maximum flexibility in dealing with their entitlement from an estate. The major benefits of a discretionary will trust include income tax savings to beneficiaries, protection from insolvency and other liabilities, capital gains tax (CGT) benefits and increased family law protection .................................... ¶19-250 • Estate planning should take into account the specific needs of the beneficiaries of the will, including spendthrift beneficiaries and beneficiaries under a disability .................................... ¶19-300 • Where inadequate planning has taken place prior to the death of a willmaker, further planning opportunities such as a superannuation proceeds trust or estate proceeds trust should be considered .................................... ¶19-400 • As part of examining estate planning, the preparation of a power of attorney should be considered. A power of attorney is a formal document by which one person (called the donor) appoints another person (called the attorney) to act on their behalf .................................... ¶19450 Consequences of death This section explains how death affects a person’s assets and financial position. When a person dies, their assets will normally be distributed to their survivors. For some assets, the distribution is made without reference to the person’s will (eg assets such as the family home that are held by spouses as “joint tenants” pass automatically to the surviving partner). These are called “non-estate” assets because they technically do not form part of the person’s estate (¶19-500). However, most assets do form part of the person’s estate, and their distribution must be made in accordance with the person’s will (¶19-505). This is handled by the person’s executor. If there is no valid will, the distribution is made in accordance with statutory “intestacy” rules — this generally means that the assets go to the person’s close relatives (¶19-515). In general, no taxes apply where a deceased person’s assets are distributed to beneficiaries. However, there are important tax rules that apply if the executor sells assets to third parties, or the beneficiaries dispose of inherited assets for their own purposes. The most important of these rules involve CGT. The effect of these will typically depend on whether the asset was acquired by the deceased before the CGT start-up date of 20 September 1985 (¶19-550). Special rules also apply to: • Different types of assets, such as family homes (¶19-605). • Different types of entitlements, such as legacies or options (¶19-655 and ¶19-685). • Different types of beneficiaries, such as children or charities (¶19-750 and ¶19-755). If the deceased person was involved in the running of a business, death raises the question of how — or whether — the business is to be carried on. This may be affected by the type of business structure (eg by whether the business was carried on by a sole trader or in partnership). Some important tax rules also apply where business assets such as stock or plant are transferred as a

result of the person’s death (¶19-800). Tax returns will have to be lodged for the part-year period up to the date of death, and must continue to be lodged for as long as the estate is deriving income (¶19-900). The taxation of estate income will depend on whether the estate has been fully administered and whether the beneficiaries are entitled to claim estate assets (¶19-850). Death may also have implications for social security entitlements and land tax liabilities. Stamp duty considerations may also arise where estate assets are transferred (¶19-950).

ESTATE PLANNING ¶19-010 Importance of estate planning Traditionally, considerable emphasis has been placed on the processes of wealth creation and wealth maintenance. However, until recent years, little emphasis has been placed upon wealth distribution after death. More recently the importance of the distribution and succession of wealth to future generations has been recognised and, as a result, estate planning has emerged as a vital part of an individual’s overall planning. What is estate planning? Estate planning can be defined as the planning and documentation of the wishes of a person for the distribution of all assets under the control of that person following death. The important aspect of estate planning is that it deals not only with those assets owned by an individual personally but the assets that are controlled by an individual. Effective estate planning requires the careful consideration of a variety of important and often complicated issues. It demands a review of the personal circumstances of the willmaker and those who are to benefit under the will. It also requires an examination of issues beyond the will, such as treatment of life insurance, superannuation and discretionary trust assets. Ultimately, the most important aspect of estate planning is the “planning”. It must be systematic and thorough and completed within the context of the willmaker’s carefully considered aims and objectives.

¶19-020 What forms part of an estate? A key issue for estate planning and for estate administration is the issue of what assets form part of the estate of the deceased. Estate assets Generally, assets owned in the personal name of the willmaker form part of the willmaker’s estate and are capable of being disposed of by the will. This includes: • real property • personal chattels • shares • cash investments • loans by the willmaker to the trustee of a trust • income or capital allocated to the willmaker from a trust

• interest in assets held as tenants in common (¶19-355). Non-estate assets Generally assets that are controlled but not owned or wholly owned by the willmaker are referred to as “non-estate assets”. Non-estate assets that cannot generally be disposed of by a will include: • jointly owned assets that are held as joint tenants (¶19-355), eg real estate and investments • unallocated assets owned by a family trust • superannuation, subject to member direction and trustee discretion (¶19-365) • life insurance proceeds (¶19-370) • account-based pensions or annuities that have a reversionary beneficiary. Additional planning is required over and above the preparation of the will in order to deal with the distribution of non-estate assets. This is dealt with at ¶19-350. Example Howard and Evelyn have three children and three major assets. They have decided to draft wills leaving one asset to each child. The family home is to be left to their eldest son, the beach house to their daughter and the investment unit to their younger son. What Howard and Evelyn had forgotten was that when they purchased the beach house and the investment unit, they were both bought in a family trust for asset protection purposes. Because they do not personally own either of these assets they will not form part of the estate and cannot be disposed by the will. Howard and Evelyn will need to alter their plans.

Distinction between joint tenancy and tenancy in common When considering estate planning, an understanding of the distinction between joint tenancy and tenancy in common is essential. Co-ownership of property is divided into two categories: • joint tenancy • tenancy in common. The defining feature of a joint tenancy is the right of survivorship that belongs to the surviving joint tenant. Upon the death of a joint tenant, the remaining joint tenant or tenants assume the total ownership of the property; the interest of the deceased joint tenant dies with him/her. In contrast, tenants in common have a discrete share in the property. Upon the death of a tenant in common, their interest in the property does not automatically pass to the other tenants but rather passes in accordance with the deceased tenant’s will. At common law, joint tenancy is presumed in the absence of a contrary intention. Joint tenant ownership:

Tenants in common ownership:

Example Abigail and her sister Phoebe agreed to buy an investment property together so that they could both build up an asset to leave to their own children. When asked how they wanted to hold the property they told their conveyancer that the property was to be owned jointly. Both Abigail and Phoebe contributed to paying off the mortgage. When Abigail died she left a will that divided her estate equally to her children. Unfortunately because the unit was owned jointly, it passed automatically by survivorship to Phoebe and Abigail’s children did not inherit what their mother had intended.

Attention should be paid to the distinction between joint tenancy and tenants in common where willmakers are contemplating the preparation of testamentary trust wills. As jointly owned assets pass immediately to the surviving joint tenant, jointly owned assets will not form part of the deceased’s estate and therefore cannot pass to a testamentary trust. This may produce undesirable results particularly where the surviving tenant was expecting half the marital assets to pass into a discretionary will trust. It is possible to negate the presumption of joint tenancy by declaring that the owners hold the asset as

tenants in common. However, careful consideration of CGT and stamp duty implications of such a declaration should be taken into account.

WILLS ¶19-030 The will For most people, one of the most important estate planning documents is the will. Despite a will being a simple document to prepare, many people die without having made a will, or die leaving a will that is out of date and which does not accurately reflect their current circumstances. A will is a legal document signed by the willmaker, sometimes called the testator, which disposes of the willmaker’s assets to the people of their choice, referred to as beneficiaries. A will determines, among other things: • who will be in charge of the administration of the estate • how the assets of the estate are to be distributed after death. However, in some instances the effect of a will may be limited. For example: • where the willmaker is in a risk occupation and has organised the ownership of assets so that all or most wealth is in a “safe haven” (for example, owned by a spouse or discretionary trust). In this situation, it would be essential for the parent and/or spouse of the willmaker to have a carefully planned will • where all assets are jointly owned and the willmaker is the first joint tenant to die • where the willmaker’s major asset is an account-based pension that has a nominated reversionary beneficiary, or • where the willmaker’s major asset is life insurance which is either owned by another person or owned as part of a superannuation policy (¶19-370). Circumstances of beneficiaries The willmaker should consider broader issues relating to the circumstances of the beneficiaries. In particular, the willmaker should consider a beneficiary’s: • eligibility, either present or future, for a means tested pension • exposure to risk that may result in insolvency • taxation status • ability to manage finances • disabilities • potential family law problems. Need for flexibility It is generally important for a will to be drafted in a flexible fashion to cater for: • unforeseeable future contingencies • changes in the willmaker’s circumstances • changes in the beneficiaries’ circumstances.

Locking beneficiaries into inflexible arrangements should generally be avoided where possible. However, in some instances there may be good reason for imposing restrictions on beneficiaries, eg where a beneficiary has special needs. Such restrictions are discussed later in the chapter.

¶19-035 Estate planning objectives Prior to preparing a will, the willmaker must establish their objectives. Such estate planning objectives will differ from person to person. The following are some common examples: • ample and appropriate provision for surviving dependants such as spouse and children • minimisation of taxation liabilities • protection of estate for beneficiaries with special needs • protection of pension entitlements of beneficiaries • succession of non-estate assets • the satisfaction of philanthropic objectives.

¶19-040 Ownership of assets When considering the preparation of a will, care should be taken by the willmaker to correctly identify those assets that form part of their personal estate. A distinction must be drawn between the assets that are owned personally by the willmaker, those assets that are controlled by the willmaker and those assets shared by the willmaker with others. Therefore, as part of the estate planning process, the willmaker must first determine: • what assets he/she owns, ie estate assets • what assets he/she controls, ie non-estate assets • how and to whom the ownership and control of those assets are to pass upon death. Refer to ¶19-020.

¶19-045 Legal requirements for will preparation There are legal requirements that need to be satisfied in order for the will to be valid and effective. Such requirements vary between state and territory jurisdictions. The usual requirements for the preparation of a valid will include the following that the: • willmaker be over the age of 18 years • will be in writing • will be signed by the willmaker • willmaker’s signature be witnessed by two independent witnesses who were present with the willmaker at the time of signing the will • willmaker possess the necessary testamentary capacity to make a will. If a will does not conform to the legal requirements, it may be held to be invalid and therefore ineffective in disposing of the estate. In this situation, the estate is distributed in accordance with the most recent valid will prepared by the willmaker or, if no such will exists, then in accordance with the relevant intestacy provisions (¶19-515).

Testamentary capacity In order for a will to be validly executed, it is essential for the willmaker to possess testamentary capacity at the time of providing instructions for the preparation of a will. In order to have testamentary capacity, a willmaker must: • understand the nature of the will document • understand the assets that will be dealt with by the will • appreciate who has a claim on their estate. With Australia’s ageing population, issues surrounding willmaker’s testamentary capacity will become more common. The time for assessing testamentary capacity is the time the instructions for its preparation are given. In order to make an adequate assessment of a willmaker’s testamentary capacity, instructions should be taken from the willmaker in person and away from possible undue influence. Particular care should be exercised when instructions are obtained from a client who: • is elderly • has a history of mental illness • is hospitalised, or • has a history of drug dependence. Mental illness and testamentary capacity The existence of a mental illness or even delusions generally does not affect a person’s ability to make a will unless it can be demonstrated that the mental illness or the delusion affected the content of the will. Example Herbert suffers from a psychiatric illness. This means that sometimes he has paranoid thoughts. During his most recent episode, Herbert wrongly believed that his youngest son had been breaking into his home in the night and re-arranging the ornaments on the mantle-piece and stealing money from his wallet. On this basis, Herbert made a will excluding his son from receiving any benefit from his estate. In this case, his delusions affected the contents of the will and compromised his testamentary capacity.

Homemade wills Homemade wills are promoted as an alternative to a will prepared by a lawyer. Will kits have encouraged more people to write wills. They have also increased the number invalid wills prepared. This means that the intentions of the willmaker are not being met and more estates are being distributed on intestacy. The most common problems that are caused by homemade wills are as follows: • The will attempts to dispose of assets that are not owned by the willmaker, for example an interest in a jointly held property. • The will does not distribute the whole estate, leaving a partial intestacy. • The will contains inflexible or unworkable conditions on the distribution of the estate. • The meaning of the will is ambiguous. • The willmaker’s handwriting is illegible. • The will does not take account of a beneficiary’s specific circumstances, such as a disability.

• The will fails to revoke previous wills.

¶19-047 Intestacy If a person dies without having made a valid will, the person is deemed to have died intestate (refer also to ¶19-515). In this situation, the person’s assets are distributed in accordance with a government formula set out in an Act of parliament commonly referred to as the intestacy rules. The government formula, which differs between jurisdictions, is applied strictly and does not allow for the intentions of the deceased to prevail where such intentions are not contained in a formally written will. There are many reasons for not preparing a will. Typical justifications include: • “I do not own sufficient assets to make a will” • “I am too busy to think about making a will at the moment — I will do it when I have more time” • “I do not want to think about death” • “I do not know what to put in it”. How does an intestacy occur? An intestacy can result from any of the following: • the failure to prepare a will • the invalidity of a will because it does not comply with the legal requirements for its preparation • the lack of testamentary capacity of the willmaker • a will that is the result of undue influence or duress • a will that is not flexible enough to cater for the change in circumstances, such as the death of a beneficiary. Unwanted consequences of intestacy There are many unwanted consequences of an intestacy. These consequences can create uncertainty in the administration of the estate and can create disputes between family members. Intestacy rules are inflexible The intestacy rules are set out in legislation. Dying without a will means that the deceased is effectively delegating the decision about the distribution of the estate to the government without regard to the specific requirements of the family. No executor appointed The failure to prepare a will also means that there is a failure to appoint an executor to administer the estate. This means that no one has the immediate authority to commence dealing with the estate. This can lead to delay and dispute. The wrong people inherit If an estate is distributed on intestacy, it might end up going to an unintended recipient, such as a separated spouse or a distant relative that the willmaker did not know. Unwanted tax consequences A distribution on intestacy can result in a person on the highest marginal tax rate inheriting personally without the flexibility that a testamentary trust can offer. It may also result in a bankrupt beneficiary missing out on their entitlement.

¶19-050 Executors One of the most important decisions that the willmaker has to make is who to appoint as executor of their estate. The executor is entrusted with the responsibility of ensuring that the wishes of the willmaker as contained in the will are carried out. A well-drawn will should include the executor’s full name, address and relationship to the willmaker. This information will provide assistance in locating the executor upon the willmaker’s death. Who should be appointed as executor? A willmaker may appoint as executor any one or more of the following: • a natural person • a trustee company, and/or • a professional adviser. Provision should be made for the appointment of a substitute executor to act in the event of the firstnamed executor being unable to act or continue to act. If more than one executor is appointed and one such executor is unable to act, the remaining executor(s) is entitled to administer the estate. Care needs to be exercised when selecting an executor. In most wills, the principal beneficiaries are usually appointed as executor, eg spouse or children. However, in some instances a willmaker may wish to appoint an independent executor or a combination of interested and independent parties. In any event, the willmaker should ensure that he/she appoints someone who is competent, trustworthy and prepared to accept the task. The willmaker should consult with the executor before making an appointment and the executor should be informed of the whereabouts of the original will. It is also a good idea to appoint someone who is likely to outlive the willmaker. When to appoint a trustee company Some estates lend themselves to the appointment of a trustee company in preference to a professional adviser, friend or family member. Trustee companies offer independence, continuity and skill in the administration of estates. Circumstances that may favour the appointment of a trustee company include: • where the willmaker does not have family or friends whom he/she regards as capable of effectively administering the estate • where the willmaker’s family circumstances are such that the appointment of an independent party is desirable, or • where the willmaker’s will contains trusts or other provisions that will require administration over a long period of time. Executor commission The willmaker should be aware that executors will be entitled to a commission for administering the estate. Generally, where the executor is a professional adviser, friend or family member of the willmaker, the determination of commission is at the discretion of the court. The level of commission is dependent upon the size of the estate and the complexity of the administration. In lieu of an application to the court seeking a determination of commission, an agreement can be entered into between the executor of the estate and the beneficiaries, all of whom must be legally capable adults. This is the preferred method as it avoids the costs associated with obtaining an order of the court. However, if any of the beneficiaries are yet to obtain the age of 18 years, or are not yet born or not yet identifiable, then such an agreement cannot be entered into. However, where a rate of commission or a proposed payment to an executor is specified in the will, it is prudent for written evidence of the willmaker’s informed consent to the inclusion of the clause be obtained before the will is signed.

While a family member or friend is entitled to charge a commission for administering the estate, a commission is rarely claimed in this situation. Generally, the level of commission chargeable by a trustee company is higher than that charged by a professional adviser, friend or relative. Trustee companies are not required to make application to the court to claim a commission. Tasks of an executor As stated earlier, the role of executor can often be an onerous one. Most executors would seek legal assistance in the administration of an estate. Expenses associated with engaging a solicitor or other professional adviser to assist with the administration are regarded as a testamentary expense and are therefore met by the estate. For a discussion of the duties and powers of an executor and trustee, see ¶19-510.

¶19-055 Appointment of guardians A willmaker who has young children or may, in the future, have young children, should appoint a guardian to take care of such children should the willmaker die prior to the children attaining their majority. The appointment of a guardian is usually included in the will as a safeguard in the event that both parents die before the children are 18 years old. The appointment of a guardian also serves to avoid the possibility of disputes between family members. The court has an overriding discretion to appoint or remove a guardian. It is the guardian’s responsibility to make the important “life decisions” on behalf of the children. The guardian must ensure that the children are adequately housed, clothed and educated. The guardianship of minor children is a responsible task. The willmaker should think carefully about the appointment of a guardian and attempt to appoint one or more persons who: • are prepared to take on the responsibility • are of a similar age to the willmaker • hold similar social and cultural views to the willmaker. Conflicts may arise between an executor and a guardian as to how a minor beneficiary’s entitlement is to be used for a beneficiary’s ongoing maintenance, education, advancement or benefit. To avoid such conflicts, a willmaker may consider appointing the same person as executor and guardian. This may, however, give rise to a conflict of interest between the duties of an executor and the duties of a guardian.

¶19-060 Gifts to beneficiaries As referred to earlier, the term “beneficiaries” refers to those people who share in the estate. Generally, a beneficiary cannot take their entitlement under an estate until he/she attains the age of 18 years. However, it is open to a willmaker to delay the gift for a longer period. This is particularly the case where a beneficiary is to receive a substantial cash amount. For example, a willmaker may choose to delay the gift until a beneficiary attains the age of 21 or 25 years. The executor of the estate would hold the relevant assets of the estate on trust until the beneficiary attains the nominated age. In making gifts to beneficiaries the particular needs of the beneficiaries must be considered. Application of income and capital for the benefit of a beneficiary Delaying a gift to a beneficiary does not necessarily prevent the beneficiary having access to the funds should the need arise. The executor of the estate has the ability to use the income and capital of a beneficiary’s entitlement for the ongoing maintenance, education, advancement or benefit of the beneficiary. A common example of such expenditure is the payment of school fees on behalf of the beneficiary. Where necessary, the will should contain specific powers enabling the executor to make applications of income and capital. If no such provisions are contained in the will, the executor and trustee will be required to act in accordance with legislative provisions dealing with application of income and

capital which are often more restrictive and inflexible. Beneficiaries’ ability to call for a delayed gift It should be noted that where all the beneficiaries of a trust are of full age and capacity, the beneficiaries may end the trust by requesting the trustee to transfer the trust assets to them. The rationale for this view is that, as a trust is established for the benefit of the beneficiaries of the will, they should be able to access the funds for their own purposes from the time they attain their majority. This is known as the rule in Saunders v Vautier (1841) 49 ER 282. In order to avoid the rule in Saunders v Vautier, the will should either specifically exclude the rule, or the gifts in the will should be contingent upon the beneficiaries attaining the nominated age.

¶19-065 Distribution of personal chattels A willmaker is also able to make gifts of specific items to beneficiaries prior to dealing with the balance of the estate. For example, a willmaker may leave family heirlooms to a beneficiary prior to the estate being sold and distributed. Such specific gifts should be clearly described to avoid confusion. On some occasions, a willmaker may provide directions for the distribution of personal items by preparing a separate list and giving this list to the executor. While such a list makes the willmaker’s intentions clear, it is not legally binding upon the executor unless it is referred to in the will and is in existence at the time of executing the will.

¶19-070 Fixed life interest A fixed life interest describes a provision contained in a will that allows a beneficiary the use and enjoyment of the whole or part of the deceased’s estate during the beneficiary’s lifetime. Typically, provision is made for the beneficiary to have the use of the income on the estate while the capital is preserved for other beneficiaries. The most common use for a fixed life interest arises where the willmaker wants to make provision for their surviving spouse (of a second marriage) or a de facto spouse while preserving the capital of the estate for children of an earlier relationship. Life estates are discussed further at ¶19-710.

¶19-075 Discretionary life interest A willmaker could consider including a discretion in the life interest clause which may deliver income splitting benefits. This is achieved by the willmaker granting the executor of the estate a discretion to share income of the life interest between a class of life tenants, most commonly the surviving spouse and children. This enables concessionally taxed estate income to be distributed to children under the age of 18 years. For a discussion of concessionally taxed estate income, see ¶19-255. However, as stated earlier, wills should generally be drafted flexibly and therefore long-term provisions such as life interest clauses should be avoided unless absolutely necessary to give effect to the willmaker’s intentions. The administration of a life interest clause becomes increasingly difficult over time and the terms of the life interest clause often become out of date regardless of how carefully they were drafted. As an alternative to a life interest clause, the willmaker may choose to consider a proportional distribution immediately upon death between their spouse and children. Careful advice regarding the CGT implications of creating a life interest or discretionary life interest should be obtained by the willmaker at the time of preparing the will.

¶19-080 Special requests contained in a will A willmaker is able to provide directions in their will relating to matters such as:

• funeral arrangements • disposal of body (eg burial/cremation) • content of funeral service. The inclusion of such requests provides assistance to the executor in planning the nature and content of the funeral service. Such requests are not generally binding on the executor. It is also prudent to make these wishes known before death to avoid the possibility that they may be overlooked in the will after death.

¶19-085 Reviewing and updating a will It is essential for a willmaker to continually review the terms of their will to ensure that it accurately represents the willmaker’s circumstances and appropriately deals with the needs of the beneficiaries of the estate. The following is a list of events that should necessitate a review of a will: • marriage (a will is invalidated by marriage), separation or divorce • commencement of a relationship • the birth of children • the death of an executor • the death of a proposed beneficiary • lifetime gifts or loans made to beneficiaries • disposal of personal items or property specifically given to a beneficiary under the will • change in a beneficiary’s circumstances, eg becoming insolvent, losing capacity, obtaining a means tested pension, or a change in financial and taxation status, or • potential disputes between beneficiaries. Effect of marriage and/or divorce Marriage As a general rule, marriage revokes a will unless the will is expressed to be made in contemplation of that marriage. When drafting a will in contemplation of marriage, the willmaker should be aware that the validity of the will can be made conditional upon the marriage taking place. Divorce In most jurisdictions, a divorce will invalidate any clause in the will that appoints the spouse as executor or that gifts them part of the estate. The divorced spouse is treated as if he/she predeceased the willmaker. In Western Australia, a divorce revokes a will where the divorce occurred after 9 February 2008. A divorce that occurred before this date does not revoke the will. In any event, a willmaker who has recently separated from a spouse or has obtained a formal dissolution of marriage should update their will. Changing a will As a will only takes effect on the death of the willmaker, a will can be altered at any time prior to death. There are two ways in which to alter a will: • by preparing a codicil. A codicil is a separate legal document that amends the existing will. It has the effect of removing a clause of the will and replacing it with an alternative clause, or adding an

additional clause • by preparing a new will incorporating the required amendments. In practice, if the changes to be made are more than simple changes, a willmaker should be encouraged to prepare a new will. The reason for this is that, once a codicil has been prepared, two testamentary documents that relate to the distribution of the estate then exist. If the codicil becomes separated from the original will, for whatever reason, the will may be administered without the amendment contained in the codicil. It should be noted that the preparation of a codicil must adhere to the same legal requirements necessary for the preparation of a will.

¶19-090 Contesting a will In some circumstances, it may be open for a will to be challenged. A challenge is made by an application to the court and may be brought on two grounds: • the will is invalid. A will may be invalid for a number of reasons: – it was incorrectly executed, or its preparation did not conform to the necessary legal requirements – it was made by a willmaker who lacked the necessary mental capacity to understand the nature and content of the document – the willmaker was placed under undue influence or pressure at the time of making the will, or • inadequate provision has been made for a beneficiary.

¶19-095 Family provision Every willmaker has the right to leave their estate to whomever they choose. This right is referred to as the “freedom of testamentary disposition”. However, the law imposes upon a willmaker a responsibility to make provision for family members and others. The extent of this obligation varies between state and territory jurisdictions Specific advice should be sought by a willmaker prior to excluding a person to whom their obligation to make provision extends. Similarly, advice should be sought by a person who is contemplating challenging a will to determine whether or not the willmaker should have provided for them. If inadequate provision is made for a person who expects to benefit under the estate and to whom an obligation was owed by the willmaker, that person may bring an application seeking further provision from the estate. It is then the executor’s role to defend the terms of the will on behalf of the other beneficiaries of the estate. Challenges to estates have significantly increased over the years. The law is essentially concerned with determining the following: • Did the willmaker have a responsibility to make provision for the person bringing the challenge? • If so, does the provision made in the will discharge this responsibility? • If the provision fails to discharge the responsibility, what additional provision is required to meet the willmaker’s obligation? Generally, the court will consider a number of factors in determining whether adequate provision has been made for the proper maintenance and support of the claimant and whether further provision should be made. Some of these factors include: • the nature of the relationship, eg spouse, child, or other eligible claimant. How the relationship is perceived by the public will also be considered. For example, in a claim by a de facto partner, witness evidence as to whether the deceased and the partner presented as a “happy couple” may be relevant • the length of the relationship

• the size and nature of the estate • the financial resources of the claimant and any other beneficiaries of the will, and • whether the claimant or any other beneficiary has any disability, mental or physical impairment or any other special needs that should be taken into account. If a willmaker has a good reason for excluding a beneficiary, it may be wise to include in the will or another form of document such as an affidavit, an explanation of the reasons for the non-provision. This will indicate that the non-provision was not merely an oversight. A willmaker should be aware, however, that the inclusion of such an explanation does not protect a will from challenge. Further, a nominal gift to the beneficiary will also not provide any such protection. Steps may be taken during a person’s lifetime to protect an estate from a claim. Some of these steps include: • moving an asset into another structure set up during their lifetime, eg a family trust. As the assets of a family trust are not allocated to any particular beneficiary, they cannot be challenged by a disgruntled beneficiary • disposing of assets during their lifetime, eg disposing of the asset to an intended beneficiary so that they are owned by the beneficiary even whilst the willmaker is alive. CGT and stamp duty implications should be considered along with the fact that the willmaker will lose control of the asset in their lifetime, or • ensuring that their superannuation does not form part of their estate. This can be done by way of a binding death benefit nomination. Advice should be sought in implementing any of these strategies particularly in the state jurisdiction[s] where the concept of “notional estate” applies. Death benefit nominations It can be difficult to challenge the payment of a superannuation death benefit which has been made in accordance with the member’s direction in a binding death benefit nomination. The extent of the challenge seems to be limited to where: • the nomination has been executed incorrectly or has not been made in accordance with the governing rules of the superannuation fund, in which case no valid binding nomination exists, or • the notional estate jurisdiction applies and deems the making of a binding death benefit nomination a relevant property transaction. Where no binding death benefit nomination has been made and the trustee’s discretion has been relied upon to determine who the member’s death benefits are paid to, then whether a challenge can be made is generally dependent on the type of fund in which the deceased’s superannuation was held. Where the fund is not a self managed superannuation fund, an aggrieved person who wishes to challenge the exercise of the trustee’s decision can make a submission to the trustee itself for the decision to be reconsidered. If the person is still aggrieved, then they may have recourse to the Australian Financial Complaints Authority (AFCA) (formerly the Superannuation Complaints Tribunal). AFCA has the power to affirm, set aside or make a new decision based on the submissions presented by the parties. The type of factors that the AFCA considers in deciding whether to affirm the trustee’s decision or set aside and make a new decision are similar to those for an estate challenge. However, consideration will also be given to: • whether there was any non-binding nomination in place which acts as a reflection of the member’s wishes in a non-binding way • whether the member made a binding nomination which has since lapsed or was prepared incorrectly

• the setting out of intentions in the deceased’s will, and • whether the death of the member intervened before retirement such that there were minor children that needed to be looked after. There is no such recourse to the AFCA for self-managed superannuation funds, meaning the only avenue to challenge the exercise of the trustee’s discretion is through the courts which may be extremely expensive and time consuming.

¶19-100 Probate It may be necessary for an executor to obtain a grant of probate to take possession of the assets of the estate. An executor is given the right to administer the estate through the will and the grant of probate is evidence of this right. The grant of probate provides the executor with the authority to collect the assets of the estate. The decision to apply for a grant of probate usually follows a detailed consideration of the nature and value of the assets of the estate. Any institution or organisation holding assets of the deceased can insist on sighting a grant of probate before allowing the executor to collect the assets. However, in some circumstances, it may be possible to collect an asset of the estate without a grant of probate. For example, most banks will consider releasing small amounts of funds (eg up to $20,000) without requiring a grant of probate. However, appropriate evidence of death, such as a certified copy of the death certificate and a certified copy of the will, is usually requested. An indemnity from the party collecting the assets may also be requested.

¶19-110 Account-based pensions or annuities The treatment of an account-based pension or annuity after death is a matter that requires consideration when reviewing estate planning. Account-based pensions or annuities are investments that pay a regular income to the investor from an established investment account using life insurance or superannuation. Upon death, the residual value of an account-based pension or annuity is paid out in a number of ways (¶19-610). Where the willmaker is intending the residual value of the investment to pass into a testamentary trust via their will, then care needs to be taken to ensure that the investment is paid to the estate.

¶19-115 Adjusting beneficiary entitlements On occasions, it may be necessary to include in a will provisions that adjust a beneficiary’s entitlement to take into account benefits received from other sources over and above a share in the residuary estate. It may also be necessary to take steps to ensure that particular assets which may not otherwise form part of the estate, such as account-based pensions and annuities or superannuation, are paid to the estate. Trust allocations While discretionary trust assets do not form part of the deceased’s estate, a will can address the existence of unequal balances in the allocated funds of the family trust that may result in one beneficiary of the will receiving a windfall relative to the other beneficiaries. Unequal loan allocations may exist because the trustee of a discretionary trust has distributed additional funds to one beneficiary in order to minimise taxation liabilities. Once the funds are allocated, the person to whom they are allocated becomes legally entitled to those allocations. If the person receiving the allocations is also a beneficiary of the willmaker’s estate, he/she has an entitlement to the trust allocations in addition to their share of the estate.

Example Don has made a will leaving his estate to be distributed equally to his children. He also has a discretionary trust. During his lifetime Don, as trustee, made large trust distributions to his youngest daughter who did not have any taxable income of her own. Upon Don’s death, his children share equally in his personal estate. However, his daughter, in addition to her entitlement from the estate, also has a legal entitlement to the trust allocations.

The inclusion of a clause in a will that adjusts a beneficiary’s entitlement to take into account family trust allocations ensures that all estate beneficiaries are treated equally from estate assets and discretionary trust allocations. Superannuation In some circumstances there may be tax advantages in paying superannuation proceeds directly to one of the willmaker’s children in preference to the other children (¶19-365). This would typically be the case where one child is still considered a death benefit dependant for tax purposes. A lump sum superannuation death benefit paid to a deceased person’s dependant for tax purposes is generally tax exempt. Death benefits dependants, for tax purposes, are: • the spouse • former spouse • another person (whether of the same or different sex) that is in a registered relationship with the deceased or with whom the deceased lived on a genuine domestic basis • children under 18 years of age, including an adopted child, a stepchild and/or ex-nuptial child and the child of a current spouse • other persons who were dependent on the deceased just before they died (eg children over 18 years of age who are financially dependent on the person), and • persons who are in an interdependency relationship with the deceased. A superannuation pension paid on the death of a superannuation fund member, prior to the member attaining the age of 60 years, to their child, will attract adult marginal tax rates and superannuation tax concessions in some cases. There are, however, restrictions on who can be paid a death benefit as a pension (¶19-610). If children are also to share equally in the residuary estate of the willmaker, then they will receive a windfall to the value of the superannuation received. Example Dorothy has made a will leaving her personal estate to be distributed equally to her children. She also has considerable superannuation entitlements. Dorothy has three children, the youngest being 16 years old. Her other two children are 23 and 25 and are non-dependants for tax purposes. Upon Dorothy’s death, the trustee of her superannuation fund determines to pay the superannuation to Dorothy’s youngest child who is regarded as a dependant for taxation purposes. Dorothy’s will provides for all three of her children to share equally in her residuary estate. As a result, Dorothy’s youngest child, in addition to her entitlement from the estate, also benefits from the superannuation.

A well-drawn will should provide for the beneficiaries’ entitlements to be adjusted to reflect superannuation proceeds received by one or more beneficiaries to the exclusion of other beneficiaries. Gifts/loans An adjustment to a beneficiary’s entitlement under a will may also be required where the willmaker has made additional provision for one beneficiary during their lifetime. Where it is the intention of the willmaker that a gift or loan made to a beneficiary should be regarded as

an advancement on the beneficiary’s inheritance, this should be clearly set out in the will. Where the gift or loan is intended as an addition to the beneficiary’s share in the residuary estate, then provisions should be included in the will forgiving the debt or confirming the gift. Example Stanley has made a will leaving his personal estate to be distributed equally between his children. During his lifetime Stanley gave $150,000 to his eldest son to assist him with the establishment of a business. Upon his death, Stanley’s children share equally in his personal estate. However, his eldest son, in addition to his entitlement from the estate, has also had the benefit of the advancement of $150,000. A question has now arisen as to how this amount is to be treated. Was it intended as a gift or an advancement of inheritance? Unfortunately, Stanley had not dealt with this issue in his will and the executor has the job of sorting it out.

CAPITAL GAINS TAX AND DECEASED ESTATES ¶19-150 Death not a disposal The death of a taxpayer does not generally constitute a taxable disposal of any part of the taxpayer’s estate for CGT purposes (Income Tax Assessment Act 1997 (ITAA97) s 128-10). However, death does represent an acquisition by the executor of the estate. This is relevant if the executor subsequently sells an asset of the estate rather than distributing it to a beneficiary. A beneficiary who takes an asset of the estate may also be subject to a CGT liability upon the subsequent sale of an asset of the estate. The incidence of CGT on an executor or beneficiary who subsequently disposes of an asset received from the estate depends on when the asset was purchased by the deceased. For a more detailed discussion, see ¶19-550.

¶19-155 Main residence exemption In dealing with the main residence of the willmaker, care should be taken to ensure that the CGT exemption that applies to the main residence is maintained (see ¶19-605).

¶19-160 Gifts to tax-exempt organisations A willmaker should be aware that leaving a gift to a tax-exempt organisation may have adverse CGT implications. Under normal CGT principles, when an asset passes to a tax-exempt organisation, no tax will be payable on a subsequent disposal by the organisation because it is tax exempt. However, ITAA97 provides that when an asset passes by virtue of death to a tax-exempt body, the deceased is deemed to have disposed of the asset to that beneficiary immediately prior to their death for a value equal to market value at the date of death. The estate is, therefore, immediately liable for any CGT liability. This is assuming that the asset was acquired by the willmaker after 19 September 1985. Therefore, the giving of an asset to a tax-exempt body may cause a CGT problem for an estate. In these circumstances, a cash gift to the organisation may be the more appropriate way to provide for a taxexempt body (see also ¶19-755). Gifts to tax-deductible organisations ITAA97 s 118-60 also allows for a capital gain arising from a testamentary gift to be disregarded provided the gift would have been deductible under ITAA97 s 30-15 if it had not been a testamentary gift. The requirements of ITAA97 s 30-15 must be satisfied for this to occur. Prior to 26 June 2005, a CGT exemption was only available to testamentary gifts that were valued by the Commissioner of Taxation at more than $5,000. From that date, any property worth less than $5,000 is deemed to have been valued by the Commissioner at a value of more than $5,000 for the purpose of the CGT exemption.

¶19-165 Testamentary trusts With the growing emphasis on wealth distribution, willmakers are now giving thought to the establishment of testamentary trusts through their wills. The concept of the testamentary trust to deal with estate assets is not a new concept, but is one that has re-emerged as an effective estate planning tool. It is through the careful drafting of a testamentary trust will that a willmaker may achieve their estate planning objectives. What is a testamentary trust? A testamentary trust is a trust established by a will that comes into effect upon the death of a willmaker. The term “testamentary trust” is used to describe a number of forms of trusts that result from the death of a willmaker. For example: • beneficiary testamentary trust, otherwise referred to as the discretionary will trust (¶19-200) • superannuation proceeds trust (¶19-405) • restricted trust (¶19-300 onwards) • discretionary life interest (¶19-075). The remainder of this chapter focuses on the various types of testamentary trusts. Discretionary life interests are discussed at ¶19-075.

DISCRETIONARY WILL TRUSTS ¶19-200 What is a discretionary will trust? The most common type of testamentary trust is the beneficiary testamentary trust or discretionary will trust. A discretionary will trust describes a form of ownership of assets whereby a trustee holds assets on trust for the benefit of one or more beneficiaries. A discretionary will trust differs from a traditional will in that rather than an asset passing into the personal name of a beneficiary (as with a simple will) under a discretionary will trust, the asset passes to a trustee who holds the estate assets on trust for the benefit of the beneficiary and a category of other discretionary beneficiaries. A discretionary will trust is created by a will. In order for a beneficiary to have the option of a discretionary will trust, the will must specifically provide for its establishment upon the death of the willmaker. If no such provision is included in the will then the will only operates to pass the estate immediately to the nominated beneficiaries without the flexibility of the discretionary will trust. Duration of discretionary will trust Once established, in most jurisdictions, a discretionary will trust has a maximum life span of 80 years. The will should be drafted to allow the trustee the discretion to end the trust at any time prior to the expiration of the 80-year period. Future control of discretionary will trust As a discretionary will trust has the capacity to run for an 80-year period, it will generally outlive the primary beneficiary. It is therefore necessary for the primary beneficiary, as part of their estate planning, to provide for the succession of control of the discretionary will trust. This can be provided for in the primary beneficiary’s will or by a separate deed prepared during the lifetime of the primary beneficiary.

¶19-205 Who controls a discretionary will trust? The will usually sets out who is to have ultimate control of each discretionary will trust established. The trust is managed by the “trustee” and all decisions regarding the management of the trust are made by the trustee. Effective control of the trust rests with the person or persons who have the power to remove and appoint the trustee. This person is usually called the “appointor” or “guardian”. The power to appoint

or remove a trustee is referred to as “the power of appointment”. Typically, one of the beneficiaries of the estate is usually the trustee and holds the power of appointment. However, the trustee and the beneficiary can be different people. Benefit and control of a discretionary will trust may be separated where the willmaker does not want the beneficiary to have complete control of the trust. This is often the case where the beneficiary is suffering from a legal disability or is likely to be unable to appropriately manage the trust. The selection of the trustee is discussed further at ¶19-305.

¶19-215 Beneficiaries of a discretionary will trust The beneficiaries of an estate who are given the “option” of taking their entitlement as beneficiaries of a discretionary will trust are usually termed “primary beneficiaries”. In addition to the primary beneficiary of the trust, the will provides for a class of additional discretionary beneficiaries who can receive income and capital from the discretionary will trust. The decision to distribute income and capital to the discretionary beneficiaries rests with the trustee of the discretionary will trust who is usually the primary beneficiary or such other person or entity nominated by the primary beneficiary. To maximise flexibility, the class of discretionary beneficiaries should be drafted widely and should include immediate family and other relatives of the primary beneficiary. In addition, other potential discretionary beneficiaries such as associated trusts, charitable organisations and related companies should also be included. To ensure that the trust does not fail for uncertainty, care should be taken to ensure that the class of discretionary beneficiaries is not too wide. Examples of potential beneficiaries of a discretionary will trust include: • the primary beneficiary • the primary beneficiary’s spouse • the siblings of the primary beneficiary • the spouse and descendants of any of the above beneficiaries and the spouse of such descendants • religious and charitable funds or institutions • associated trusts and companies. Family trust elections are an important consideration when determining the beneficiaries. Such an election, if made, will narrow down the choice of beneficiaries for practical purposes (¶1-525). The will should not allow for the definition of discretionary beneficiaries to be amended. This prevents the will infringing the rule against the delegation of testamentary power. This is also a concern for distributions made from an estate directly to an existing discretionary trust. The trust deed should clearly state that the definition of beneficiaries cannot be altered. The will should also contain broad definitional provisions. For example: • definition of spouse — spouse should be defined to include de facto partners/domestic partners, and partners of the same gender • definition of children — children should include stepchildren, adopted children, ex-nuptial children and children of a spouse. Once again, the impact of such broad definitions on a family trust election will need to be considered. Does a beneficiary have to leave a trust in place? In the absence of any specific restrictions imposed by the willmaker on the beneficiary, a beneficiary generally has the choice of whether to invoke the discretionary will trust upon the willmaker’s death. The

executor usually makes this decision in consultation with the relevant beneficiary. Typically, the default position is to establish this trust. If a beneficiary elects to establish the discretionary will trust, the beneficiary can subsequently end the trust and take the assets of the trust personally. However, careful planning and advice should be obtained prior to the vesting of a trust that has been established.

¶19-225 Establishment of more than one trust Where the willmaker is leaving their estate to more than one primary beneficiary, the will should make provision for each beneficiary to take their entitlement as the trustee and beneficiary of a separate trust. This avoids the problems that may arise where one discretionary will trust is jointly controlled by siblings, and enables each beneficiary to deal with their respective entitlements in different ways. For example, one beneficiary may choose to leave the discretionary will trust in place while another may terminate the trust and take the entitlement personally, while a third primary beneficiary may elect not to invoke the trust at all. No consultation is required between the beneficiaries.

PLANNING OPPORTUNITIES OF DISCRETIONARY WILL TRUSTS ¶19-250 Planning opportunities of discretionary will trusts The establishment of a discretionary will trust provides a beneficiary of an estate with maximum flexibility in dealing with an entitlement. The usefulness of a discretionary will trust to a beneficiary depends upon their specific needs.

¶19-255 Income tax savings Generally, minor children are subject to penalty rates of tax on unearned income. The amount of unearned income that a minor can earn before penalty rates of tax apply is $416. Income over this threshold is taxed at 66% up to $1,307 after which income is taxed at 45%. This taxation regime is subject to some exceptions, one of which relates specifically to income generated by a trust that is created by will or codicil. Penalty rates of tax do not apply to “excepted trust income”, which includes assessable income of a trust estate that resulted from a will, codicil or an intestacy, or a court modification of a will, codicil or intestacy (Income Tax Assessment Act 1936 (ITAA36) s 102AG). When combined with a carefully drafted discretionary will trust, this allows for the tax-effective treatment of estate income.

Note ITAA36 s 102AE provides that adult tax rates will apply to investment earnings resulting from bequests to minors.

A discretionary will trust allows for the splitting of the income generated by the discretionary will trust among the potential discretionary beneficiaries of the trust. As mentioned previously, the trustee of the discretionary will trust has complete discretion to determine who receives the income of the discretionary will trust. The trustee may determine to distribute income to the primary beneficiary or to any one or more of the discretionary beneficiaries of the trust. Tax is paid on the income of the trust at the marginal tax rate of the beneficiaries who receive it. Therefore, by selecting beneficiaries on low marginal tax rates, the trustee can minimise the taxation liability of the trust. The trustee can choose to distribute income to minor beneficiaries of the trust with

each beneficiary being able to receive the benefit of the adult tax-free threshold. Example Bradley is a highly qualified scientist who is employed as a chemical researcher. Bradley’s income is taxed at the top marginal tax rate. Bradley’s wife is a part-time physiotherapist who is also earning an excellent income. Bradley and his wife have three minor children. Bradley’s father died, leaving Bradley a share in the balance of his estate valued at $500,000. Bradley’s father, on advice, had prepared a will that enabled Bradley to take his entitlement under the estate as the trustee and primary beneficiary of a discretionary will trust. Bradley invested his inheritance and last financial year his investment had a return of $15,000. As trustee, Bradley resolved to allocate the income equally between his children. Because the income was generated by a trust created by a will, all his children are taxed at adult tax rates. The result for Bradley is that no tax is paid on the trust income. Had no provision been made for a discretionary will trust in his father’s will, Bradley would have paid tax on the income at his marginal tax rate and as a result lost almost half of the income to tax.

The trustee should be aware, however, that once the income is allocated to a beneficiary of a discretionary will trust the beneficiary has a legal entitlement to the amount allocated. The trustee can also distribute income from the trust to charitable and religious beneficiaries. As many such beneficiaries have tax deductibility status or are tax exempt, no tax is paid on allocations to such organisations. The taxation treatment of a discretionary will trust should be distinguished from an inter vivos or lifetime trust set up by the deceased during their lifetime. Usually, if a beneficiary of such a trust is under the age of 18 years, then any trust income allocated to the beneficiary is taxed at a penalty rate over and above an initial tax-free threshold of $416. Superannuation pensions should be considered in some cases. However, in some jurisdictions discretionary will trusts are subject to higher rates of land tax.

¶19-260 Protection from insolvency and other liabilities The second planning opportunity of a discretionary will trust is that it potentially provides protection from the repercussions of insolvency and other potential liabilities. Assets that pass to a discretionary will trust from an estate are held for the nominated primary beneficiary until the trustee elects to distribute such assets. The assets are not owned personally by the beneficiary and therefore do not form part of the beneficiary’s personal estate. A creditor or other person claiming against the beneficiary, therefore, cannot obtain the assets held in the trust. Where a primary beneficiary is experiencing solvency or other liability problems, the primary beneficiary should not accept the role of trustee but nominate another person or entity to act on their behalf. The trustee would administer the trust fund on the primary beneficiary’s behalf until such time as the primary beneficiary is discharged from bankruptcy or settles other claims against him/her. The primary beneficiary could then assume the trusteeship of the trust.

¶19-265 Capital gains tax opportunities A discretionary will trust also provides the opportunity to minimise the incidence of CGT liability if an asset of the discretionary will trust is subsequently sold. As with the income of the trust, the trustee can select which of the discretionary beneficiaries of the trust should take the capital gain. By choosing to distribute the capital gain to a beneficiary on a low or nil income, the CGT liability can be significantly reduced.

¶19-270 Family law protection A discretionary will trust may also provide some limited protection for a beneficiary who is experiencing family law difficulties. By providing for a beneficiary’s entitlement to be held in a discretionary will trust, the primary beneficiary

can isolate estate entitlements from personal assets. This may protect their estate entitlements from family law property proceedings. Caution should be exercised so as not to overstate the protection a discretionary will trust provides to a beneficiary experiencing family law problems. If a beneficiary has family law difficulties at the time of receiving their inheritance or at some time shortly after the receipt of the inheritance, as a general rule, the beneficiary’s spouse will have limited access to the funds. This is due largely to the way in which the Family Court approaches the division of marital or de facto property. It should be remembered that the family law property jurisdiction is highly discretionary; any judge will analyse the “fairness” of a settlement by looking at the total assets and financial resources which each party is left with or has access to. The court not only readily looks behind the “corporate veil”, it tends to shred it. The Family Court also has the power under the Family Law Act 1975 to make orders against third parties and can override the terms of a trust. This may result in the court making an order weighted against the party who has an interest in a discretionary will trust or, in some circumstances, a division of the assets of that trust. Technically, the first issue for the Family Court is to analyse the respective contributions of each party to the creation of the marital or de facto wealth. In most cases, the beneficiary’s partner (including a spouse) will be unable to prove a contribution to the inheritance and so the court will be slow to directly give the other party a share of that inheritance. The second issue for the court is the likely relative needs of the parties in the future. In determining this matter, the court will take into account that the beneficiary has access to the inheritance as a source of wealth. This may have an impact on the way in which the court divides the balance of the relationship assets, excluding the inheritance. For example, if the beneficiary has a large inheritance, he/she may not “need” as much of the relationship assets to support himself/herself and so the other party may get more. To be certain that a discretionary will trust provides protection, the will would need to be drafted carefully to ensure that the primary beneficiary does not have control of the trust. This would mean: • not appointing the primary beneficiary as trustee of the fund • removing any provisions that allow the primary beneficiary to assume the trusteeship in the future • ensuring that the primary beneficiary does not hold the power to remove and appoint the trustee • not allowing capital to be distributed to the primary beneficiary. This makes the discretionary will trust less attractive to the beneficiary as control of the trust is largely removed from him/her.

¶19-275 Trusts and Age Pension entitlements Assets held by a trust over which an aged pensioner has control or into which a pensioner has transferred assets are assessable for the means test. The relevant provisions dealing with the Centrelink treatment of trusts are contained in Pt 3.18 of the Social Security Act. Applicable tests Pursuant to Pt 3.18, trusts in general will be subject to two separate tests of attribution: • a control test, and • a source test. The basis of the control test is that the controller of a structure should be considered to be the de facto owner of the assets of the structure. Control can be both formal (where a pensioner controls the structure personally) or informal (where the structure is controlled on behalf of the pensioner).

The source test will attribute the structure’s assets to the pensioner where that person transfers assets to the trust for inadequate consideration or has provided services to the structure for inadequate remuneration. Impact of rules The rules impact directly on discretionary will trusts. If the trust is a testamentary trust activated as a result of a person’s spouse dying on or before 31 March 2001, the trust assets and income will be attributed to the formal controller of the trust. If the trust is being administered for the benefit of the surviving spouse and if the surviving spouse is exercising informal control, attribution will be to the surviving spouse and the assets will be assessed for the means test. Where testamentary trusts are activated as a result of death after 31 March 2001, the surviving spouse will be attributed with the assets and income of the trust if: • the surviving spouse directly controls the trust (irrespective of whether they are a beneficiary), or • an associate has control and the surviving spouse is a potential beneficiary. The rationale for the rules is that if a surviving spouse has direct control of a trust, they can exercise their discretions as trustee to benefit themselves. Further, if an associate (eg family member or professional adviser) has control and the surviving spouse is a potential beneficiary, it is reasonable to expect that the surviving spouse will share in the benefits of the trust.

RESTRICTED TRUSTS ¶19-300 What is a restricted trust? A willmaker can establish a restricted trust for the beneficiaries of an estate. A restricted trust does not possess the flexibility of the discretionary will trust (¶19-200). A restricted trust is a trust that contains additional restrictions regarding the exercise of the trustee’s discretion to distribute income and capital. It is not as limited as a fixed trust where the trustee has no discretion. A restricted trust is most commonly established where the beneficiary has special needs. Spendthrift beneficiary A willmaker may establish a restricted trust where one of the intended beneficiaries of the estate has displayed an inability to appropriately manage money. Such a beneficiary is often referred to as a “spendthrift beneficiary”. In this situation, the willmaker’s fear is that a share of the estate distributed directly to the spendthrift beneficiary will be dissipated unwisely. Some of the most common causes of potential financial mis-management are: • gambling or substance addiction • a pattern of poor financial decision-making • an unsuitable peer group. In the event that a willmaker wants to leave a gift to a spendthrift beneficiary they should establish a restricted trust that allows a separate trustee to manage the spendthrift beneficiary’s entitlement for him/her. This ensures that the spendthrift beneficiary does not have control over the entitlement and is therefore unable to waste the estate. Beneficiary under a disability A restricted trust may also be established for a beneficiary who does not have the capacity to administer a share of an estate because of an intellectual disability or other injury. In this instance, it would be unwise

to put such a beneficiary in control of the estate proceeds. Not only would he/she be unable to make the necessary decisions regarding investment and expenditure of the funds, but he/she may also fall victim to pressure from other individuals who may seek to use the funds for their own purposes. Special disability trusts A special disability trust is a trust established solely for the future care and accommodation needs of a person with a severe disability. It can either be created by deed or by will. However, only one trust can be created for a beneficiary. A special disability trust is distinguishable from other types of restrictive trusts by the purposes to which the income and capital can be applied. Features of a special disability trust A trust is a special disability trust if the requirements of Pt 3.18A of the Social Security Act are complied with. Beneficiary requirements The legislation requires that the trust has only one principal beneficiary. This beneficiary must satisfy the impairment or disability conditions set out in the Social Security Act and Div 11B of the Veterans’ Entitlements Act 1986. A person with a severe disability is someone aged 16 or over who: • has an impairment that would qualify a person for a disability support pension (under the Social Security Act) or an invalidity service pension or invalidity income support supplement under the Veterans’ Entitlements Act • as a result of the disability, the beneficiary is not working and has no likelihood of working for a wage at or above the relevant minimum wage, and who • either: – lives in an institution, hostel or group home in which care is provided for people with disabilities and for which funding is provided (wholly or partly) under an agreement between the Commonwealth, the states and the territories, or – has a disability that would, if a person had a sole carer, qualify the carer for carer payment or carer allowance • if the beneficiary is under the age of 16, the beneficiary must qualify as a “profoundly disabled child” under the Social Security Act. Sole purpose requirement The sole purpose of a special disability trust must be to meet the “reasonable care and accommodation needs of the beneficiary”. A special disability trust can only pay for: • the cost of accommodation for the person with a severe disability • extra care costs arising from the disability, and • incidental expenses such as fees for professional trustees, investment and accounting expenses. Apart from accommodation, the trust can be used to pay for items that are necessary because of the disability. For the 2020/21 financial year, up to $12,500 per year can be spent on any requirements of the principal beneficiary that are not related to reasonable care and accommodation. Apart from the $12,500 limit, a special disability trust cannot pay for things that a person without a disability would ordinarily buy or be used to meet ordinary day-to-day expenses.

Guidelines have been developed to assist in determining what is regarded as “reasonable care and accommodation”. Examples of what amounts to reasonable care needs include: • professional care and case management required for, or because of, the principal beneficiary’s disability • therapy if approved in writing by the medical practitioner of the principal beneficiary • specialised food specified by a doctor as essential for the principal beneficiary’s health • mobility aids required because of the principal beneficiary’s disability. The following are examples of what does not amount to reasonable care needs: • food other than food specified by a doctor as essential for the principal beneficiary’s health • day-to-day toiletries such as toothpaste, soap and shampoo • recreation and leisure activities • medical needs that are not required for, or because of, the principal beneficiary’s disability. The regulations also set out guidelines for what amounts to “reasonable accommodation needs”. Accommodation needs must arise as a direct result of the disability. It includes modifications to the principal beneficiary’s place of residence. It does not include payments to an immediate family member whether it be for the purchase of real estate or rental payments. Trust property requirements There are prohibitions on what assets can be transferred into a special disability trust. They are: • assets contributed by the principal beneficiary of the trust or the principal beneficiary’s partner unless the asset is all or part of a bequest or a superannuation death benefit (except from the principal beneficiary’s partner) that has been received no more than three years before the transfer to the trust occurs • compensation proceeds received by or on behalf of the principal beneficiary. Income of special disability trust In relation to the income generated by the trust, it is not attributed to any individual under the Social Security Act and any income amount that the principal beneficiary receives is not income of the beneficiary for the purposes of the Social Security Act. Assets of a special disability trust For the purposes of the Social Security Act, the assets of a special disability trust are not included in the assets of the principal beneficiary of the trust up to the assets value limit of the trust. The assets value limit for the financial year 2020/21 is $694,000. This is indexed annually on 1 July. For the purposes of determining the asset value limit, the value of any right or interest of the trust in a principal home of the principal beneficiary is disregarded. Transfers and deprivation rules The Social Security Act contains provisions that modify the normal deprivation rules on a disposal of assets by an aged pensioner. What this means is that a family member of a principal beneficiary can gift up to $500,000 to a special disability trust and the amount gifted is not included in the value of the assets on which the family member is assessed for Centrelink purposes. The Social Security Act contains a definition of immediate family members, which includes parents, legal guardians, brothers, sisters, grandparents and others. Other matters

The Social Security Act also sets out other matters including the following: • the treatment of the trust at cessation • trustee requirements including recording and auditing expectations • trustee qualifications and appointment. All needs protective trust An alternative to a special disability trust is an “all needs protective trust”. An all needs protective trust describes a restricted trust created for a beneficiary under a disability that allows for expenditure on behalf of the beneficiary beyond “reasonable care and accommodation”. However, the assets of an all needs protective trust are assessable against the beneficiary for the income and assets test. Consideration may be given to dividing a beneficiary’s entitlement between a special disability trust and an all needs protective trust to balance expenditure requirements and the desire to maintain pension eligibility.

¶19-305 Control of restricted trust The control of a restricted trust is a matter to which the willmaker must give careful consideration. The trustee of the restricted trust should be someone who is sympathetic to the needs of the beneficiary of the trust. The trustee has onerous responsibilities, including making all decisions regarding the investment and expenditure of the fund. Such expenditure must be undertaken for the ongoing maintenance and benefit of the beneficiary. Selecting the trustee In selecting the trustee, the willmaker should exercise care to ensure that a conflict of interest situation does not occur. This typically arises where another beneficiary of the estate is placed in control of the funds. If the trustee is a person who can share in the income of the trust fund during the lifetime of the beneficiary, or in the capital of the trust fund upon the death of the beneficiary, then the trustee may be reluctant to expend the money on the beneficiary in an attempt to ensure a healthy balance in the trust fund when the beneficiary dies. The willmaker should consider appointing a committee of trustees or an independent trustee to manage the restricted trust. Example Arthur has two children, Bruce and Celia. Celia is intellectually disabled. During his lifetime, Arthur has taken all responsibility for the ongoing care of Celia. Prior to his death, Arthur prepared a will that provided for the establishment of a restricted trust for Celia’s benefit. It was Arthur’s intention for Celia’s inheritance to be managed for her by a responsible third person. Arthur appointed his son Bruce as trustee of the trust fund. The will stated that the income and capital of the fund was to be paid or applied for Celia’s benefit, with any balance of the income not so expended to be either paid to Celia directly, accumulated or distributed to other beneficiaries of the estate. The only other beneficiary is Bruce. The will also provided that, upon Celia’s subsequent death, the balance of the trust fund was to be distributed to Bruce. Bruce had some pressing financial commitments that he was struggling to meet. He regarded Celia’s needs as being appropriately met by the special accommodation home in which she lived, although he had never made enquiries as to her specific requirements. He used all of the income of Celia’s trust fund to top up his own income. Any income he did not need he accumulated to ensure that there would be a healthy balance in the trust fund once Celia passed away. Meanwhile, Celia went without.

¶19-310 Application of trust fund Guidance on how a restricted trust fund is to be administered should be included in the will. For example, the will may provide for the income of the fund to be applied for: • the provision of suitable accommodation for the beneficiary, or

• the maintenance, support, education or advancement of the beneficiary. The will should also deal with any surplus income not expended in any given year. Such income could either be: • allocated directly to the beneficiary • accumulated as an addition to the fund, or • allocated to other beneficiaries of the trust. Where the surplus income is to be paid to other beneficiaries under the will, the terms of the trust should make it clear that the interests of the special needs beneficiary should take precedence over any other interest or expectancy as to income from the trust fund. A beneficiary’s entitlement to a means tested disability support pension should be considered when drafting a restricted trust.

¶19-315 Death of restricted trust beneficiary If a trust is established for the benefit of a special needs beneficiary, the trust fund may not form part of the beneficiary’s personal estate in which case it cannot be willed by him/her. In such situations the willmaker must make provision for the distribution of income and capital from the fund upon the death of the beneficiary. This requires careful planning. If a special needs beneficiary is likely to have children of their own, then it would be usual to provide for such children. If it is unlikely that there will be any children, an alternative distribution should be included.

NON-ESTATE ASSETS ¶19-350 Non-estate assets As discussed at ¶19-115, additional planning is required to provide for the succession of non-estate assets.

¶19-355 Jointly owned assets Jointly owned assets pass automatically to the surviving joint tenant regardless of the contents of the will. Where relevant, consideration should be given to severing the joint tenancy so that the respective tenants can dispose of their interest through their will. The decision of whether or not to sever a joint tenancy should be considered in light of the type of assets involved, the ease with which the manner of holding the asset can be changed and any CGT and stamp duty consequences that may result from such a change.

¶19-360 Assets of discretionary trusts In order to deal with the succession of assets owned by a discretionary trust, it is necessary to deal with the future control of the discretionary trust. To provide for the future control of a discretionary trust, the terms of the trust deed establishing the fund should be reviewed to determine who has ultimate control of the trust. It should be noted that the assets of a discretionary trust consist of unallocated income and capital. Loans made to the trustee of a discretionary trust are a liability of the trust and are therefore not an asset of the trust. Future control of discretionary trusts The control of a discretionary trust usually rests with the person or persons who have the power to

appoint and remove the trustee of the discretionary trust. This person is usually termed the “appointor” or “guardian”, and the power is often referred to as “the power of appointment”. Control of the discretionary trust does not often reside with the shareholders of a corporate trustee of a discretionary trust. Where a willmaker desires the control of a discretionary trust to pass to those people who are intended to benefit from the trust assets, the terms of the discretionary trust deed should be amended by deed to provide for the power of appointment to pass jointly to those people (often referred to as “specified appointors”). To effectively deal with the succession of the trust, the terms of the amending trust deed should contain the following: • that where there is more than one specified appointor, the appointors must act unanimously. This guards against the majority of appointors voting to exclude the minority of appointors from benefit • appointment of an interim appointor to act where the specified appointors have not attained the age of 18 years. It should be made clear that this interim appointor must act in the best interests of the specified appointors • provisions that provide protection for a specified appointor who lacks the intellectual capacity to manage their own affairs • procedures for resolving deadlocks between specified appointors. When contemplating amending a trust deed, it should be established from the outset that the trust deed allows for an amendment. If no such amendment power exists in the deed, application must be made to the Supreme Court seeking an order to amend the deed.

Tip The potential for the amendment to amount to a resettlement of the trust should be considered, particularly where the assets of the trust comprise assets other than cash. A resettlement will usually have stamp duty and CGT consequences.

Tax Determination TD 2012/21 provides that a trust deed amendment made in accordance with a power of amendment contained in the trust deed will generally not give rise to a resettlement.

¶19-365 Superannuation proceeds The payment of superannuation proceeds upon death is not generally governed by the terms of the will. The governing rules of the superannuation fund determine the manner in which death benefits are paid (¶19-610). As part of the estate planning process, superannuation beneficiary nominations should be reviewed. Further, where the superannuation fund is a self managed superannuation fund (SMSF), the future control of the fund must be dealt with. This necessitates dealing with the control of the trustee. Extra care is required when dealing with a superannuation fund if the trustees have the discretion as to who shall receive a death benefit. This is because the discretion of the trustees is often held by an individual who, by virtue of possessing this power, determines where the superannuation proceeds are distributed. There is a danger that the proceeds may pass to the wrong people. The trust deed should be reviewed to determine who takes control of the superannuation fund upon the death of a member. This is usually the surviving member(s) and/or the member’s legal personal representative.

Considerations where estate nominated as beneficiary Where superannuation benefits are to be paid to the estate of the relevant fund member, the will may need to be drafted specifically to deal with superannuation proceeds. The failure to do so may have unwanted tax consequences. The objective is to ensure that the class of beneficiaries able to receive the proceeds is limited to the tax dependants of the deceased. Superannuation death benefits paid to the estate of the deceased fund member will be exempt, to the extent that tax dependants are to benefit. Each situation should be reviewed individually. It may be prudent in certain circumstances that the will should allow the surviving spouse to: • take the proceeds personally • take the proceeds as a beneficiary of a specially drafted trust (the beneficiaries of which are limited to dependants for tax purposes), or • direct that the proceeds be paid to other dependants of the deceased. The willmaker may also express a wish that if he/she leaves dependants who are under the age of 18 years at the date of their death, the proceeds may be paid to a trust referred to as a superannuation proceeds trust (¶19-405). Like a discretionary will trust, this will provide concessional rates of tax on income generated by the trust and distributed to minor beneficiaries. Death benefit tax matters When considering estate planning matters and superannuation, the treatment of superannuation from a taxation point of view must be considered (¶19-610 and ¶4-420). Binding death benefit nomination When making a superannuation beneficiary nomination, a binding death benefit nomination should be considered (provided the rules of the fund allow such a nomination to be made). A binding death nomination allows a member to direct the trustee of the fund to whom the death benefits should be paid on death, which the trustee must follow. That is, a valid binding death benefit nomination overrides the exercise of the trustee’s discretion. In making a binding death nomination, the following should be considered: • only beneficiaries who are classified as such under the Superannuation Industry (Supervision) Act 1993 (SISA) and/or the estate of the member can be nominated • the nomination must be in writing and signed by two adult witnesses • the specific requirements for the preparation of the nomination contained in the trust deed must be complied with • it must dispose of the whole benefit • it may lapse every three years. If these requirements are not complied with, the binding nomination may be deemed to be invalid, which would allow the trustee a discretion in payment of the death benefit. Under some funds’ governing rules, there are alternative binding nominations which do not lapse every three years, eg where the member exercises discretion as to who is to receive the death benefit and the trustee consents to that exercise (SISA s 59(1)). ASIC has also warned financial advisers specifically about meeting requirements for witnessing signatures. The regulator noted that it is aware of a widespread practice among financial advisers of witnessing or having staff members witness client signatures on binding death benefit nomination forms without being in the presence of the signatory. In some cases, forms have also been backdated. The Australian Taxation Office has confirmed, in SMSFD 2008/3, that there is no requirement for self managed superannuation funds to comply with the witnessing requirements or the requirement that the

nomination needs to be reviewed every three years. This means that, for example, the binding death benefit nomination can continue indefinitely (as opposed to lapsing after three years). However, it should be noted that the fund’s trust deed will contain the mechanism for members being able to make binding nominations which may still have these formality requirements, notwithstanding the ATO’s view. If this is the case, the trust deed’s process still needs to be followed or the trust deed amended. Case study In the case of Munro v Munro the importance of complying with the terms of a superannuation fund trust deed when preparing a binding death benefit nomination was highlighted. Mr Munro made a binding death benefit nomination in which he nominated the “Trustee of Deceased Estate” to receive 100% of the death benefits. The terms of his trust deed listed who could receive the death benefits. One of the options was expressed to be “the member’s legal personal representative”. Following Mr Munro’s death a dispute arose as to the validity of the binding death benefit nomination. The trustees of the superannuation fund gave notice that they did not intend to honour the nomination because it was invalid on the basis that it did not comply with the terms of the trust deed. The court agreed that the nomination was invalid. The court concluded that the words “Trustee Deceased Estate” was not the same as “the member’s legal personal representative”. As a result, the trustees of the fund retained discretion to distribute the death benefits.

¶19-370 Life insurance In dealing with life insurance proceeds, the crucial issue is who is to be the beneficiary of the life insurance policy. If the life insurance policy is owned by the willmaker, life insurance proceeds may be paid to any nominated beneficiaries, or the willmaker’s estate. In the latter case, the proceeds can be dealt with by the terms of the will. Again, however, the will should be drafted specifically to deal with life insurance proceeds. If the life insurance policy is not owned by the willmaker but their spouse, such proceeds will pass automatically to the surviving spouse and will not form part of the willmaker’s estate. Therefore, the life insurance proceeds are unable to pass into a testamentary trust. Example Basil is an electrical contractor and engineer who runs a successful consulting business. He has decided that he should take out a life policy. Having his wife’s best interests at heart, he nominates her as the owner of the policy. Basil mentions this to his brother-in-law Dale, who is also in the electrical contracting industry. Dale seeks advice from his financial adviser and solicitor. Like Basil, he takes out a life policy, but on the advice of his adviser he elects to own the policy in his own name. While working together on a large electrical contracting project, a large power surge hits the equipment Basil and Dale are working on and they are killed instantly. Although both Basil and Dale had taken out the same life policy, Dale’s family will be much better off. As Dale chose to own the policy personally, the proceeds pass into his estate and into a discretionary will trust for the benefit of his wife. As a result, she has the ability to share income on the investment of the life insurance between her children and other beneficiaries, greatly minimising her taxation liability. By nominating his wife as the owner, Basil’s life insurance passes automatically to her and does not form part of his estate. She may be unable to make full use of the testamentary trust provided for in Basil’s will. This is disappointing given that she has three children under the age of 18 years. She may, however, be able to transfer the proceeds to a trust pursuant to ITAA36 s 102AG(2)(c)(iv) to achieve a similar effect. This arrangement would be similar to the superannuation proceeds trust discussed at ¶19-405.

For more details on life insurance, see ¶7-000.

FURTHER PLANNING OPPORTUNITIES ¶19-400 Taking advantage of the rules for minors In some instances, the ability to utilise the benefits provided for in ITAA36 Pt III Div 6AA (which apply to

minors known as “prescribed persons”) is lost, often because the willmaker has not received the appropriate advice or has failed to take adequate steps to effectively plan their estate. However, there exists a number of opportunities to make use of the concessional rates of tax provided for by Div 6AA after the death of a willmaker, even if the willmaker’s will did not specifically provide for this. The two most valuable examples in the estate planning context are: • the superannuation proceeds trust (¶19-405) • the estate proceeds trust (¶19-410).

¶19-405 Superannuation proceeds trust A superannuation proceeds trust is a specially drafted trust that is capable of receiving superannuation proceeds on behalf of the beneficiary of a deceased fund member. It is usually prepared by deed after death but prior to the payment of the superannuation. It may also be set up as part of the terms of the will. Superannuation proceeds trusts are covered by ITAA36 s 102AG(2)(c)(v). This section provides that income derived by the trustee of a trust, that is the result of the investment of superannuation proceeds transferred to the trustee directly as the result of the death of a person, is excepted trust income. It is therefore subject to the concessional rates of tax. There are a number of matters that need to be carefully considered prior to establishing a superannuation proceeds trust. Determination of trustee of superannuation fund Unless there is a valid binding nomination in place the decision as to how superannuation proceeds are paid out typically rests with the discretion of the trustee of the fund. It is therefore necessary for the trustee to agree to pay the proceeds directly to the trustee of the superannuation proceeds trust. This requires a formal determination to pay to the trustee. At the outset it is advisable to check the superannuation trustee’s requirements prior to finalising the trust deed. In this context, the issue of whether the trustee of the fund is also holding a binding death benefit nomination should also be considered. Definition of beneficiaries Generally, to avoid the superannuation death benefits being taxed when paid into the trust, the definition of beneficiaries in the trust deed needs to be drafted so as to ensure that the proceeds are held on trust only for persons deemed to be tax dependants (¶19-365) of the fund member. Distribution of income from trust Any income generated by the superannuation proceeds trust can be distributed to beneficiaries of the trust. By selecting beneficiaries on low marginal tax rates, income tax liabilities can be minimised. The ability of children to utilise the adult tax-free thresholds makes the superannuation proceeds trust more attractive as a planning tool. Capital requirement One drawback of the superannuation proceeds trust is the requirement that the capital of the trust must ultimately vest in the concessionally taxed beneficiaries of the trust (ITAA36 s 102AG(2A)). The capital requirement does not apply if the superannuation proceeds trust is established by will. However, like any other trust, a superannuation proceeds trust has a life span of 80 years. The concessionally taxed beneficiaries cannot receive the capital until the trustee determines to wind up the trust, which may be before 80 years. The trustee can, however, advance part of the capital to a beneficiary prior to the vesting of the trust. The trustee can also lend the trust capital to a nonconcessionally taxed beneficiary. In what situation should a superannuation proceeds trust be established? The most obvious situation in which to establish a superannuation proceeds trust is where there are minor dependants of the deceased fund member. This will enable the concessional rates of tax to be utilised to

maximum benefit. If there are no such minor dependants, there is little value in establishing a superannuation proceeds trust. Example Godfrey died, leaving his wife Sally with the full-time care of four minor children. Godfrey had considerable funds in superannuation. Sally was the nominated beneficiary of his superannuation fund. Sally has received advice that she should seek to have the superannuation proceeds paid to a superannuation proceeds trust rather than to her directly. Her adviser explained that this would enable her to share income between herself and her children and minimise her overall taxation liability. She was surprised to hear that her young children could take $18,200 tax-free each year. Sally made contact with the trustee of the superannuation fund, who agreed to make a determination to pay the proceeds directly to the trustee of the superannuation proceeds trust. Last year the superannuation proceeds trust earned almost $73,000 in income. By sharing this around her family, Sally was able to eliminate all taxation liability. Sally is well aware that while she can share in the income of the trust during her lifetime, the capital of the fund must be preserved for the benefit of her children. This does not concern Sally as she intends her children to benefit from her own personal estate in any event.

As an alternative to establishing a superannuation proceeds trust, the death benefit may be paid (via a trustee) to a child as a pension. In this way, a child pension can provide a reliable income stream for dependent children to meet costs such as education expenses. The pension will generally be an accountbased pension (if paid from a self managed superannuation fund). An account-based pension requires a minimum percentage of the account balance to be paid to the child and it is able to be commuted by the minor child once he/she turns 18. A pension paid to a minor child (or child who is over 18 and under 25 but financially dependent on the deceased, or has a disability) must be cashed out as a lump sum on the day on which the child attains the age of 25 years (unless it is commuted earlier or unless the child has a disability of a kind described in s 8(1) of the Disability Services Act 1986). From 1 July 2017, the payment of a child pension from superannuation is subject to modified transfer balance cap rules. These rules limit the amount of the superannuation death benefits that can be taken as an income stream by a minor child. For income streams commenced after 1 July 2017, the following applies: • Where the parent was in accumulation phase and has no transfer balance account, the funding for the child pension is limited to the parent’s transfer balance cap (and if more than one child, then shared). Any amount over the transfer balance cap must be taken as a lump sum. • If the parent is in retirement phase and has a transfer balance account at their death, then a child can receive the parent’s death benefit income stream (and if more than one, then shared). • If the parent is in retirement phase but also has a balance in accumulation phase, the child pension can only arise from the parent’s income stream and not from the funds in accumulation. The funds in accumulation will need to be taken as a lump sum. The existence of the modified transfer balance cap rules make the use of child pensions potentially less attractive. Consideration needs to be given to determining the effectiveness of a child pension in the context of these rules.

¶19-410 Estate proceeds trust An estate proceeds trust is a specially drafted trust that is established by a deed after the death of the willmaker to receive assets on behalf of the beneficiaries of the willmaker’s estate. The major reason for establishing an estate proceeds trust is that it is capable of utilising the income tax concessions for income allocated to minor beneficiaries (¶19-255). It is created pursuant to ITAA36 s 102AG(2)(d)(ii), which provides that income derived by the trustee of a trust as a result of the investment of estate proceeds transferred to the trustee on behalf of a beneficiary of the estate within three years of

the date of death, is excepted trust income. Distinction between discretionary will trust and estate proceeds trust There are significant differences between an estate proceeds trust and a discretionary will trust. An estate proceeds trust is subject to greater restrictions than apply to a discretionary will trust and is therefore less flexible than a discretionary will trust. The estate proceeds trust is subject to a capital requirement and an intestacy restriction that do not apply to a discretionary will trust. Capital requirements The requirement for concessionally taxed beneficiaries to ultimately receive the capital of the trust fund that applies to superannuation proceeds trusts also applies to estate proceeds trusts. This requirement does not apply to discretionary will trusts. There is no obligation upon the trustee to transfer the capital of the trust fund to the beneficiaries when they turn 18 years of age. This need only take place when the trust ends. Advances of capital can be made prior to the vesting of the trust. Transfer of proceeds within three years In order for the concessional rates of tax to apply to income generated by an estate proceeds trust, the estate proceeds must be transferred to the trust within three years of the date of death. If the transfer does not take place within this time, the opportunity to make use of the concessional rates of tax is lost. Intestacy restriction The level of assets capable of being transferred to an estate proceeds trust is limited to those assets that the minor beneficiary would have received had the willmaker died intestate. Typically, the implications of ITAA36 s 102AE(10) and 102AG(7) are that the income tax concessions only apply to income from that proportion of the estate that would have been received by the minor had there been an intestacy. This restriction does not apply to a discretionary will trust. Intestacy rules of each jurisdiction should be considered when contemplating the establishment of an estate proceeds trust. In the jurisdictions where a surviving partner receives the entire estate on intestacy, an estate proceeds trust cannot be established.

POWERS OF ATTORNEY ¶19-450 Powers of attorney A related area of importance that should be considered as part of a thorough estate plan is the preparation of a power of attorney. A power of attorney is a formal document by which one person (called the donor) appoints another person (called the attorney) to act on their behalf. The power of attorney is a separate document from the will and operates only during the lifetime of the donor. All authority given to the attorney therefore ceases upon the death of the donor. The legal requirements for the preparation of a power of attorney are embodied in statute. Each state and territory of Australia has its own Acts of parliament that regulate the preparation of a power of attorney. Therefore, the requirements vary considerably from one jurisdiction to another. The discussion provided in this chapter will not focus on the specific legal requirements as they apply in each state and territory, but will deal more generally with the various types of powers of attorney and their operation.

¶19-455 Types of powers of attorney Depending upon the law prevailing in a particular state or territory, there are a number of different types of powers of attorney:

(1) general power of attorney (2) enduring power of attorney (all states other than the Northern Territory) (3) advance personal plan (Northern Territory) (4) enduring power of attorney (medical treatment) — in Victoria only prior to 12 March 2018 (5) appointment of medical treatment decision maker — in Victoria only after 12 March 2018 (6) advance health care directive/advance care directive (7) supportive attorney (Victoria only) (8) enduring guardian. Prior to 1 September 2015, an enduring power of guardianship could be made in Victoria appointing a guardian to make personal and lifestyle decisions. After 1 September 2015, these types of decisions are made by an attorney appointed under an enduring power of attorney. Enduring guardians appointed prior to 1 September 2015 can still act. It should be noted that not all Australian jurisdictions make provision for the preparation of all types of enduring powers of attorney. The relevant law of each jurisdiction should be referred to in each situation. General power of attorney Most jurisdictions allow for the creation of a general power of attorney. The defining feature of a general power of attorney is that the authority given by the donor to the attorney ceases immediately upon the donor becoming mentally unable to manage their own affairs. In practice, this means that if, as a result of an accident or other trauma, the donor has lost capacity to act, the attorney is also unable to act. A general power of attorney is usually prepared where the donor intends the attorney to perform a specific function for a limited period. For example, the donor may appoint another person to manage their finances while a donor is on holiday. Unless there is good reason for preparing a general power of attorney, a donor would be best advised to prepare an enduring power of attorney. Enduring power of attorney The difference between a general power of attorney and an enduring power of attorney is that the authority given by the donor to the attorney pursuant to an enduring power of attorney continues beyond the donor’s own incapacity. This allows the attorney to continue acting notwithstanding that the donor has lost their mental capacity. An enduring power of attorney is usually created to appoint a person or multiple people to make legal and financial decisions for the donor where the donor is unable to make the decisions for themselves. In Victoria, the ACT and Queensland, an enduring power of attorney can also make personal/lifestyle decisions. In Tasmania, New South Wales and Western Australia, personal/lifestyle decisions are made by an enduring guardian; in South Australia, by a person appointed by an advance care directive; and in the Northern Territory, by a person nominated in an advance personal plan. An enduring power of attorney is an essential document, particularly for older people who are finding it increasingly difficult to attend to their personal affairs. Guardianship and Administration Act 2019 (Vic) The Guardianship and Administration Act 2019 was passed in May 2019 and came into effect from 1 March 2020.

The Act repealed the Guardianship and Administration Act 1986 and re-enacts with amendments, a legislative framework that provides for: • the meaning of decision-making capacity and how it is to be assessed • the appointment by the Victorian Civil and Administrative Tribunal (VCAT) of a guardian or an administrator for a person with a disability who does not have decision-making capacity, subject to appropriate limitations and safeguards • the appointment by VCAT of a supportive guardian or a supportive administrator to support a person with a disability to exercise decision-making capacity • the appointment by VCAT of an administrator for a missing person, and • the retention of the Public Advocate as an independent statutory office to promote the rights and interests of persons with a disability. The reforms include a presumption that a person has decision-making capacity unless evidence is provided otherwise and recognises that a person has decision-making capacity if they can make decisions with support. The law also creates new offences for guardians or administrators who dishonestly use their appointment for financial gain or cause loss to the represented person, with anyone found guilty facing up to five years in prison. VCAT will also be afforded the power to make more flexible and tailored orders, in order to promote the person’s personal and social wellbeing. Medical and healthcare decisions All jurisdictions allow for the appointment of a person to make medical/healthcare decisions. The form and the name of the document that grants the power differ across jurisdictions. In Victoria, prior to 12 March 2018, a person could prepare an enduring power of attorney (medical treatment). The enduring power of attorney (medical treatment) allowed the donor to authorise an agent to make decisions regarding medical treatment. From 12 March 2018, a person in Victoria now appoints a medical treatment decision maker with authority to make medical treatment decisions instead. An enduring power of attorney (medical treatment) made before the law changed is recognised under the new Act and remains valid. In Tasmania, New South Wales and Western Australia, healthcare decisions are made by an enduring guardian. In the ACT and Queensland, healthcare decisions are made by the enduring power of attorney; in the Northern Territory by a person appointed under an advance personal plan; and in South Australia by a person appointed under an advance care directive. It should be noted that a person appointed to make medical/healthcare decisions cannot refuse provision of the basic necessities such as food and water on behalf of the donor. Further, the power given to a donor does not authorise euthanasia. Voluntary assisted dying On 29 November 2017, the Victorian Parliament passed legislation allowing for voluntary assisted dying. The new laws came into effect on 19 June 2019 after an extended period of implementation. The legislation allows a Victorian adult with a terminal illness to request an assisted death in certain circumstances. Voluntary assisted dying is only available to Victorians who are over the age of 18 and are capable of making decisions. To be eligible, the person must have been resident in Victoria for a minimum of 12 months. The person must be suffering from an incurable illness and must have a life expectancy of less than six months. The person must also be experiencing suffering that is determined to be intolerable. Two doctors must assess the person’s eligibility for voluntary assisted dying. Advance health care directive/advance care directive

In most jurisdictions, an advance health directive/advance care directive can be signed specifying what medical treatment is to be administered in relation to future health care in the event of a loss of capacity. In the jurisdictions where no formal document exists, it is still a good idea for medical wishes to be written down and given to the medical agent or the donor’s doctor. Supportive attorney In Victoria, a donor can appoint a supportive attorney to help make and implement decisions in relation to personal and financial matters. The powers granted to the supportive attorney enable the attorney to: (1) provide information or access information on behalf of the donor (2) communicate with organisations on behalf of the donor, and (3) carry out the donor’s decisions. The attorney’s powers only exist so long as the donor has capacity. The attorney cannot make significant financial decisions on the donor’s behalf. Personal/lifestyle decisions A personal or lifestyle decision refers to a decision that relates to the day-to-day care of the donor. Typically this includes decisions about where the donor lives, what personal services the donor requires, and decisions regarding minor health care and dental treatment.

¶19-460 Scope of attorney’s authority By appointing an attorney, a donor is providing that attorney with the ability to do all acts and things that the donor can do personally. In relation to the general power of attorney and the enduring power of attorney, this generally covers decisions regarding financial, legal and, in some jurisdictions, personal matters. This would include the following: • paying bills • writing cheques • performing banking transactions • selling and purchasing real and personal property. Therefore, the authority given to an attorney is extremely wide. The extent of the powers granted to a supportive attorney is more limited. There is an implied restriction on the exercise of an attorney’s authority. It is an established principle that the use of a power of attorney by the attorney contrary to the known wishes and directions of the donor is a breach of trust. Therefore, there resides in the donor the right to instruct the attorney not to act on the document or to act in a particular way.

¶19-465 Legal requirements for power of attorney Capacity to give power of attorney As with the preparation of a will, the donor must have sufficient mental capacity in order to appoint an attorney. Requisite capacity has been held to be the ability to understand the nature of the document itself and the nature of all acts or transactions authorised by the particular document. A power of attorney executed by a person without the requisite mental capacity is void and all transactions carried out pursuant to the document are also void. There may be slight differences in the standard of competence required in each jurisdiction.

Registration of powers of attorney Most jurisdictions require powers of attorney to be registered. A failure to register a power of attorney may result in the power of attorney, and all subsequent deeds executed by the attorney, being of no force. The specific requirements of each jurisdiction should be reviewed. Supervision of attorneys While there may be a requirement in some jurisdictions to register a power of attorney, there is little or no formal supervision of the actions of an appointed attorney. However, there is an implied obligation on behalf of the attorney to act in the best interests of the donor. As stated earlier, a failure to do so would be regarded as a breach of trust. With the extensive power given to an attorney, it is essential that the donor appoints someone who is trustworthy and competent and who is prepared to take on the responsibility of attorney. Jurisdiction of assets In order for an attorney to have the authority to act on behalf of the donor, the authority given to the attorney must conform to the requirements of the jurisdiction in which the attorney may need to act. This may mean that a donor needs to prepare powers of attorney that comply with requirements in more than one jurisdiction. Example Frieda is about to embark on the holiday of a lifetime. She has made all the necessary arrangements to ensure that everything proceeds smoothly while she is away. She has a diverse investment portfolio which includes shares, cash investments and investment properties. One of her investment properties is a unit overlooking the beach at Broome. Frieda has updated her will and prepared an enduring power of attorney in readiness for her trip. She has appointed her brother, Derrick, as her attorney. Prior to leaving, Frieda commenced negotiations to sell her Broome unit. However, she was unable to finalise negotiations prior to her departure. She has explained to her brother Derrick that he may need to sign documents on her behalf while she is away. Four days after Frieda’s departure, a letter arrives from a solicitor in Western Australia requiring her signature. Derrick exercises his authority under the enduring power of attorney and signs on Frieda’s behalf. He then returns the document to Western Australia satisfied that he has fulfilled his duty. However, a week later the document is returned with a note advising Derrick that the authority given under the Victorian enduring power of attorney does not conform to the requirements of the Western Australian legislation and is therefore ineffective in giving Derrick authority to act for Frieda in the sale transaction. Derrick is told that an application needs to be made seeking recognition of the Victorian document before the transaction can proceed. This threatens the finalisation of the sale.

¶19-470 Multiple attorneys A donor is able to appoint more than one attorney to act on their behalf. This is often done as a precaution where one attorney may be unable to act for the donor because of illness, death or absence from the jurisdiction. When appointing more than one attorney, the donor must give thought as to whether or not that authority is granted jointly or jointly and severally. It should be noted that in some jurisdictions, only one decision maker can be appointed to act at a time for healthcare decisions. Joint appointments Where attorneys are appointed jointly, it is necessary for both attorneys to sign on behalf of the donor in order for the authority granted under the power of attorney to be validly exercised. The appointment of joint attorneys can be inflexible and impractical. However, a donor may regard the appointment of joint attorneys as a safeguard against the inappropriate exercise of the attorneys’ authority. Joint and several appointments

Where attorneys are appointed jointly and severally, the attorneys are given the flexibility of acting together where appropriate, or acting separately where necessary. A joint and several appointment is the more flexible approach. By majority In some jurisdictions, the donor can also appoint attorneys to act by majority under an enduring power of attorney. This does not apply to the appointment of medical agents or decision makers appointed for healthcare decisions.

¶19-475 Revocation of power of attorney A donor is generally free to revoke the authority given under a power of attorney at any time providing the donor has the capacity to do so. A power of attorney may be revoked by the donor preparing a formal revocation of power of attorney. If the donor uses this method of revocation, then a copy of the revocation document should be delivered to the attorney and the original revocation document should be registered in those states/territories where registration is applicable. All copies of the power of attorney should also be retrieved from the attorney. Alternatively, the donor may choose to revoke the authority by destroying the original power of attorney document. Care should be exercised in this instance to retrieve all known copies of the document.

CONSEQUENCES OF DEATH ¶19-500 What forms part of a person’s estate When a person dies, the person’s assets must be distributed to their living beneficiaries or be held on their behalf. In order to do this, the assets owned by the deceased must be identified. As discussed at the start of this chapter, not all assets form part of the person’s estate (¶19-020).

¶19-505 Where there is a will If a person has made a will, the estate assets will be distributed in accordance with the instructions in that will. The basic requirements for the preparation of a valid will are discussed at ¶19-030. The person responsible for carrying out this distribution is called an executor. Usually people name their executor in the will. For example, an executor may be a trusted friend or relative, an adviser such as a solicitor or accountant, or a trustee company. For planning considerations, see ¶19-050. Before the assets are distributed under the will, the executor has to get approval from the court (“getting probate”). This involves proving that the will is valid and has not been superseded by a later will. There is normally no difficulty with this, although occasionally disputes may arise where a person has left a number of wills, or there are doubts about the person’s mental capacity. Often the will requires that property be held on trust into the future, instead of being distributed immediately. Typically, this occurs if there are beneficiaries who are children. The person responsible for holding the property — the trustee — should also be appointed in the will. The same person is often appointed executor and trustee, though this is not essential. For convenience, trustee is used in this chapter to cover executors. Sometimes, if the person held substantial assets overseas, a separate executor/trustee may be appointed to administer the overseas assets. Those assets, and their distribution, will typically be subject to the law applying in that place.

¶19-510 Duties and powers of executor/trustee The executor normally has the following tasks:

• arrange for the funeral • identify, collect and take control of the person’s assets • identify and pay any liabilities • pay the costs of administering the estate • distribute the assets • lodge tax returns and pay taxes. A separate bank account will need to be kept for all estate monies. Trustees may be personally liable if assets are distributed to the wrong beneficiaries or if they do not act in accordance with the instructions in the will. Most executors would seek legal assistance in the administration of an estate. Expenses associated with engaging a solicitor or other professional adviser to assist with the administration are regarded as a testamentary expense and are therefore met by the estate. Powers of the trustee What the trustee can do is affected by trust law and the terms of the will. Here are some of the important considerations: • the will may need to give the trustee specific power to carry on the testator’s business, or to act as a business partner, borrow money, and to sell, retain or lease out assets. The will may also specify the amount of any commission that the executor may claim • giving the trustee a wide discretion may be important because there can be significant tax differences according to the way in which particular assets are dealt with • the trustee may need the power to accumulate income (defer its distribution) and to have wide discretion in the manner in which it is distributed from time to time. As explained at ¶19-850, this may attract favourable tax treatment • the trustee should also have the power to direct particular types of income or gains to particular beneficiaries so as to maximise any tax benefit. For example, tax may be minimised if foreign income can be directed to non-residents • where a beneficiary is a minor, the trustee would also normally be given wide powers to invest on behalf of the minor and to make advances to the minor for education or maintenance purposes • the trustee may also need to have the power to deal with the situation where trust income is different from income for tax purposes. This can occur, for example, where bonus shares are issued — although bonus shares may be capital under trust law, they may be assessable income under tax law. For further details, see ¶19-050.

¶19-515 Where there is no will Some people do not leave a will at all, or their will is invalid. This is called dying “intestate”. In this situation, the estate assets will be distributed to the deceased’s dependants and relatives in accordance with rules set out in special intestacy legislation. Typically, the beneficiaries of an intestate estate will be the spouse, children or other near relatives. The person responsible for asset distribution is called the administrator of the estate. This is usually a person who has an interest in the estate. This person will have to be approved by the court. If no one applies for this approval, the estate may be administered by the Public Trustee. An administrator may also be appointed if no executor was nominated in the will, or if the named executor declines to accept the responsibility.

Sometimes, a person may dispose of some of their assets but not all. For example, the will may direct that certain payments be made, but fail to say how the balance of the estate is to be dealt with. This is called a partial intestacy. The intestacy rules will therefore apply to determine how that balance is to be distributed. Occasionally, people die without a will and without dependants, relatives, or anyone else who is interested in the estate. When this happens, the estate will generally be administered by the Public Trustee. If no dependants or relatives can be found, the estate goes to the government. It may also happen that a will is not necessary. This may occur, for example, if all the deceased’s assets were “non-estate” assets (eg where they were held in joint tenancy with a spouse (¶19-500)).

¶19-520 Where a will is contested A will may be contested on the ground that it is not valid (¶19-090). Even where there is a valid will, a person may contest it on the ground that they have not been adequately provided for. The category of people who can bring such a claim varies between states and territories (¶19-095). Generally, the court’s discretion to vary the effect of the will in these situations is quite wide. However, this also differs depending on the state or territory. The estate trustee needs to be careful not to distribute assets until any claims such as these have been dealt with.

DISTRIBUTING THE ASSETS ¶19-550 General tax rules that apply to the distribution of assets Although death duties have applied in the past, no death or similar duties currently apply in Australia. This means that, generally speaking, no tax becomes payable on the following transactions: • assets passing from the deceased to the personal representative • assets passing from the personal representative to the beneficiaries, or • assets passing directly to the beneficiaries. (There are limited exceptions in relation to superannuation funds and non-residents: see ¶19-755 and ¶19-765 respectively. Of course, it is also possible that death duties will apply in another foreign country if the deceased was a resident of that country or had assets there.) Although these transactions normally do not attract tax, there are many special tax rules that apply if: • the personal representative disposes of an asset to a third party, or • beneficiaries dispose of inherited assets for their own purposes. These transactions can give rise to significant liabilities for tax, particularly CGT. Sometimes these rules operate differently for different types of assets (such as dwellings), different types of entitlements (such as life interests) or different types of beneficiaries (such as non-residents). Refer to Chapter 2 for a general outline of the CGT regime, and ¶19-150 in regard to CGT and deceased estates. It is essential that these differences be taken into account in determining the value of specific distributions to beneficiaries. For example, leaving a CGT-exempt family dwelling to a person may be worth considerably more than leaving a CGT-assessable holiday house with the same market value.

¶19-555 Tax on disposals of estate assets As already noted, CGT may apply if beneficiaries dispose of estate assets, or if the trustee disposes of them to third parties who are not beneficiaries. The CGT effects of these transactions vary according to:

• when the deceased died • when the deceased acquired the assets. Death before 20 September 1985 If the deceased died before 20 September 1985, all of the deceased’s assets at the time of death are treated as if they were acquired pre-CGT by the estate trustee or beneficiaries. This normally means that no CGT applies if the trustee or beneficiaries later dispose of those assets. This applies even if the asset was actually transmitted to the beneficiary after 19 September 1985. Death after 19 September 1985 In the more usual case, where the deceased died after 19 September 1985, the following rules apply in calculating CGT where the asset is disposed of by the estate trustee to a third party, or by the beneficiary: • if the asset had been acquired by the deceased before 20 September 1985, the trustee/beneficiary is taken to have acquired the asset at the date of death, for an amount equal to the market value of the asset at the date of the deceased’s death • if the deceased acquired the asset after 19 September 1985, the trustee/beneficiary is taken to have acquired the asset at the date of death, for an amount equal to the relevant cost base for the deceased at the date of death. (Special rules apply to dwellings and trading stock: see ¶19-605 and ¶19-805 respectively.) Depending on the date of death, the calculation of the capital gain on a subsequent disposal of the asset may be affected either by indexation or by the CGT discount rules (¶2-210). However, neither of these can apply unless the disposal occurs more than 12 months after the deceased acquired the asset. These rules apply whether the asset passes to the beneficiary: • directly under the will • under a power of appropriation exercised by the trustee • under a court order made under the testator’s family maintenance rules, or • under an out-of-court deed of arrangement that was entered into to settle entitlements, provided that the only consideration given was the variation or waiver of claims over other assets. They do not apply if the beneficiary acquires the asset as purchaser, eg where the beneficiary exercises an option to purchase an estate asset (¶19-685), or where the trustee exercises a power of sale in favour of a beneficiary (¶19-680).

TAX RULES THAT APPLY TO DIFFERENT TYPES OF ESTATE ASSETS ¶19-600 Tax rules for different types of estate assets In this section we look at specific types of assets and examine any applicable modifications to the general CGT rules described above, as well as any other special tax rules that have practical importance. The rules which govern the tax treatment of an asset vary according to the type of asset. For example, the treatment of dwellings is covered by the CGT regime, whereas the income tax rules govern the treatment of superannuation assets.

¶19-605 Estate asset: dwellings Preserving the CGT exemption Where one or more dwellings are included in the estate, it will be important to obtain the benefit of the

CGT exemption which applies to a person’s main residence, or to preserve as far as possible the CGT exemption which applies to pre-CGT assets. This will mean that some specific conditions will need to be complied with. The two main factors that affect the CGT exemptions are: • when did the deceased acquire the dwelling? If it was before 20 September 1985, an exemption may be available irrespective of whether the deceased used the dwelling as a main residence. If it was acquired after 19 September 1985, the conditions for exemption are much stricter • when did the trustee or beneficiary dispose of the dwelling? If it was within two years of the deceased’s death, it will be easier to obtain the exemption. Dwelling acquired before 20 September 1985 Where the deceased acquired the dwelling before 20 September 1985, CGT will not apply if the trustee or beneficiary disposes of the dwelling within two years after the deceased died. The use to which the dwelling was put, either before or after death, is irrelevant. In other words, it is not necessary that the dwelling was used as a main residence at any time — it may, for example, have been used as a holiday house, a rental investment, or simply left vacant. A different rule applies if the trustee or beneficiary disposes of the dwelling more than two years after the deceased died. In this situation, CGT does not apply if the dwelling was used for the whole of that period as the main residence of the deceased’s spouse, a person who has a right under the will to occupy the dwelling, and/or the beneficiary to whom ownership passed. If the dwelling was used as a main residence by those people for only part of the time after the deceased died, a pro rata CGT exemption applies. Example A beneficiary disposes of a dwelling four years after the death of the deceased. The beneficiary occupied the dwelling as a main residence for three of those four years and leased it out to third parties for the other year. Three-quarters of the capital gain would be exempt.

If the relevant people never used the dwelling during the time after the deceased died, the CGT exemption does not apply. Dwelling acquired after 19 September 1985 The exemption rules that apply where the deceased acquired the dwelling after 19 September 1985 are as follows. Dwelling disposed of less than two years after death CGT does not apply if both of the following conditions are satisfied: • The trustee or beneficiary disposes of the dwelling less than two years after the deceased died. • The dwelling was the deceased’s main residence at the date of death. If the dwelling was used for only part of the deceased’s period of ownership as their main residence, but was not in such use at the date of death, a partial CGT exemption applies. If the dwelling was never the deceased’s main residence, no CGT exemption applies. Dwelling disposed of more than two years after death CGT does not apply if all the following conditions are satisfied: • the trustee or beneficiary disposed of the dwelling more than two years after the deceased died • the dwelling was the deceased’s main residence at the date of death • for the whole of the period from death until disposal, the dwelling was the main residence of the

deceased’s spouse, a person who has a right under the will to occupy the dwelling, and/or the beneficiary to whom ownership passed. A partial CGT exemption applies if: • the dwelling was used for part of the deceased’s period of ownership as a main residence, but not at the date of death, and/or • the dwelling was used as the main residence of the deceased’s spouse, etc for only part of the period from the date of death until disposal. This partial exemption is based on the total period of time for which the dwelling was used as a main residence in these ways, compared with the total period from the deceased’s acquisition up to the date of disposal. This means that even if the deceased never used the dwelling as a main residence, a partial CGT exemption may apply if it was used as such by the relevant persons after the date of death. On 27 June 2019, the Commissioner issued the Practical Compliance Guideline PCG 2019/5 dealing with the requirement to dispose of the property within two years of death in order to maintain the CGT exemption. This Guideline allows the executor or beneficiary of the will to assume that the Commissioner has granted an additional period of time not exceeding 18 months after the two-year limitation has expired within which to deal with the property. The Guideline sets out a number of conditions that need to be met in order to qualify for the additional period. A number of the conditions relate to issues that caused delay in dealing with the property such as a dispute in relation to the will or the complex nature of the estate. Cost base of dwelling For CGT purposes, the trustee or beneficiary is taken to have acquired the dwelling for its market value at the date of death if: • the dwelling was acquired by the deceased before 20 September 1985, or • the dwelling was the deceased’s main residence immediately before death, and was not being used for income-producing purposes at that time. Otherwise, the trustee or beneficiary is taken to have acquired the asset for an amount equal to the relevant cost base for the deceased at the date of death. Other rules relating to dwellings Dwelling acquired by trustee for beneficiary The will may provide for the trustee to purchase a dwelling for occupation by a beneficiary. There is no CGT liability when the trustee transfers the dwelling to the beneficiary. In addition, if the beneficiary uses the dwelling as a main residence, CGT will not apply when the dwelling is subsequently disposed of. If the beneficiary only uses it partly as a main residence, a partial CGT exemption will apply. Where deceased inherited the dwelling It may happen that a dwelling has passed through a chain of deceased estates, eg where a dwelling is passed down through successive generations. If it has been partly used as a main residence since the first death in the chain, any CGT on its subsequent disposal by a trustee or beneficiary will be reduced to reflect that period of use. This of course does not apply if the sale by the trustee or beneficiary is CGTexempt in any event under the rules stated above. Elections made after death There are various situations where a taxpayer can elect to have property treated as a main residence, eg where a residence is in the course of construction. These elections can be made after death by the estate trustee, or by a surviving joint tenant. Principal home excluded from social security assets test The principal home and up to two hectares of attached land are not counted as assets for the purposes of the social security assets test (see Chapter 6). An exemption also applies to the proceeds from the sale of

a previous home that will be used to purchase another home within 12 months.

¶19-610 Estate asset: superannuation Death benefits include payments made from the deceased’s own superannuation fund, an industry or public offer fund or approved deposit fund. They also include payments made by the deceased’s employer (but not accrued annual or long service leave) (¶19-625). Payments from an annuity can also be death benefits (¶16-900). Who is entitled to death benefits? Upon death, the death benefit of a person can be paid out in one of four ways, depending on the fund rules or the policy terms: • to a reversionary beneficiary who has been identified to receive the pension of the person on their death. In this instance the pension does not form part of the willmaker’s estate. It passes immediately to the reversionary beneficiary and is therefore a non-estate asset (this option is only relevant in circumstances where the deceased member was in receipt of a superannuation pension) • to the estate of the willmaker in accordance with the fund/product rules (ie neither the fund or trustee nor the member direct whom the benefit is to be paid to). In this case, it is an estate asset and can be distributed in accordance with the terms of the will • to a beneficiary chosen at the discretion of the trustee. A beneficiary could be the deceased estate or one or more of the dependants of the deceased. While this option provides the trustee with flexibility, the member does not control who will receive the death benefit (even if he/she lodges a form indicating their preferences in this regard). Thus, it is difficult to “estate plan” with any certainty, or • to the beneficiary at the binding nomination of the member. Again, a beneficiary could be the estate and/or a dependant of the original member. This method enables the member to “estate plan” with certainty as no one else has a say as to who will receive the benefit. It also provides flexibility in that a binding nomination can be varied or replaced at any time by the member to take account of any change in family circumstances. Note, however, that under some fund rules a binding nomination will generally lapse if it is not reviewed within three years. A superannuation death benefit can only be paid to a person’s dependants and/or to their estate. A dependant is defined in the SISA as including: • a spouse • a child of the person, or • any person with whom the person has an interdependency relationship. A person who is financially dependent on the deceased at the time of death is also considered a superannuation dependant for the purposes of payment of death benefits. “Spouse” in relation to a person now includes: (a) another person (whether of the same sex or different sex) with whom the person is in a relationship that is registered under a law of a state or territory prescribed for the purposes of s 2E of the Acts Interpretation Act 1901 (Cth) as a kind of relationship prescribed for the purposes of that section, and (b) another person who, although not legally married to the person, lives with the person on a genuine domestic basis in a relationship as a couple. This means that same-sex partners are included as spouses and therefore as dependants, in addition to married couples and de facto couples of the opposite sex. “Child” in relation to a person includes:

(a) an adopted child, a stepchild of a current relationship or an ex-nuptial child of a person (b) a child of the person’s spouse, and (c) someone who is a child of the person within the meaning of the Family Law Act 1975. In relation to a deceased member, a “child” would therefore also include the child of a same-sex spouse provided that the spouse was still alive at the date of death of the member. While a lump sum death benefit can be paid to any person who is a dependant and/or the estate of the deceased, there is a restriction on who can be paid a pension as a death benefit. If a member dies on or after 1 July 2007, the recipient of a pension can only be: • a dependant of the member, and • in the case where the dependant is a child of the member: – is less than 18 years of age, or – being more than 18 years of age: (i) is financially dependent on the member and less than 25 years of age, or (ii) has a disability of a kind described in s 8(1) of the Disability Services Act 1986. If a pension is able to be paid to a child as outlined above, the pension benefit must be cashed as a lump sum on the day on which the child attains age 25 (unless it is commuted earlier) unless the child has a disability of the kind described in s 8(1) of the Disability Services Act 1986. Taxation of death benefits Death benefit paid directly to dependants Where a death benefit is paid directly to a superannuation dependant, the tax treatment depends on whether the recipient is a death benefits dependant of the deceased as defined by the ITAA97. A death benefits dependant of a deceased person is: • the deceased’s spouse or former spouse • the deceased’s child, aged less than 18 years • any person with whom the deceased person had an interdependency relationship just before he/she died, or • any other person who was a dependant of the deceased person just before he/she died. The definition of “spouse” and “child” for the purposes of the ITAA97 are the same as those contained in the SISA for the purposes of determining whether such person is a dependant. A lump sum death benefit paid to a death benefits dependant will be tax-free when paid to the dependant. Interdependency relationships An interdependency relationship includes personal relationships where the relationship is not that of a spouse, child (for tax purposes, a child is under 18 years of age) or a financial dependant. An example of this type of relationship which may fall into this category is two elderly sisters who live together and provide each other with financial support and personal and domestic care. The definition provides that two persons (whether or not related by family) have an interdependency relationship if: • they have a close personal relationship • they live together

• one or each of them provides the other with financial support, and • one or each of them provides the other with domestic support and personal care. SISR 1.04AAAA specifies matters that are to be taken into account in determining whether two people have an interdependency relationship or had an interdependency relationship immediately before the death of one of the persons. All of the circumstances of the relationship between the persons including the following should be considered: • the duration of the relationship • whether or not a sexual relationship exists • the ownership, use and acquisition of property • the degree of mutual commitment to a shared life • the care and support of children • the reputation and public aspect of the relationship • the extent to which the relationship is one of mere convenience • any evidence suggesting that the parties intend the relationship to be permanent. The following are examples of relationships that fall within the definition of “an interdependency relationship”: • elderly siblings who reside together, or • an adult child who resides with and cares for an elderly parent or parents. The following are examples of relationships that will not fall within the extended definition: • people who share accommodation for convenience (eg flatmates), or • people who provide care as part of an employment relationship or on behalf of a charity. In the case of Williams v IS Industry Fund Pty Ltd [2018] FCAFC 219, the Full Federal Court rejected an appeal by the father of the deceased that a superannuation death benefit payment should have been made to him. The father had not established the existence an interdependency relationship between himself and his son. One circumstance of the case leading to this conclusion was that the son had been intermittently staying with the father in between set breaks of his employment (vacation) at a holiday resort. Consequently, it had not been established that the father and son had been living together for the purposes of an interdependency relationship. Death benefits paid to non-death benefits dependants A lump sum death benefit paid to a person who does not meet the definition of a “death benefits dependant” but is considered a superannuation dependant is taxed according to whether the deceased’s superannuation balance comprises the tax-free component, the taxable component, or both components. The tax-free component of the benefit (which comprises the crystallised segment and the contributions segment) is tax-free. However, where the death benefit comprises the taxable component (made up of the element taxed in the fund and possibly an element untaxed in the fund), the recipient of the death benefit will be entitled to a tax offset to ensure that the rate of tax on the element taxed in the fund does not exceed 15%, and the rate of tax on the element untaxed in the fund does not exceed 30%. The Medicare levy must also be added.

Death benefit paid to the estate If a lump sum benefit is paid to the trustee of a deceased estate, the tax treatment of the benefit is based on whether death benefits dependants or non-death benefits dependants have benefited, or may be expected to benefit from the death benefit. To the extent that one or more of the beneficiaries of the estate are death benefits dependants who have benefited, or will be expected to benefit, the death benefit is treated as if it had been paid directly to the death benefits dependant. Alternatively, if one or more of the beneficiaries of the estate are non-death benefits dependants, the payment is treated as if it were paid to a non-death benefits dependant and taxed accordingly. Taxation of pensions The taxation of an income stream received by a death benefits dependant will depend on the age of the deceased person or the recipient. An income stream will be tax-free if the recipient was 60 years or over when the benefit was received and/or the deceased died aged 60 or over. However, the untaxed element of the fund will be taxed at the marginal rate of the recipient with a tax offset equal to 10% of the untaxed element of the taxable component. If the deceased died aged 60 or under and the recipient is also under 60 years when the benefit is received, then the tax-free component will not be subject to tax; however, the recipient will be entitled to a tax offset equal to 15% of the element taxed in the fund of the taxable component. The untaxed element of the fund of the taxable component will be taxed at marginal rates with no tax offset. From 1 July 2017, a transfer balance cap was introduced. This imposes a limit of $1.6m (indexed) that can be used to commence an income stream from superannuation, meaning that an income stream payable to a death benefit dependant must not cause the dependant to exceed their transfer balance cap. Terminal condition benefits Lump sum benefits can be accessed tax-free by a member of a superannuation fund if they are suffering from a terminal medical condition. A terminal medical condition exists if: • two registered medical practitioners have certified jointly or separately that the member suffers from an illness, or has incurred an injury, that is likely to result in the member’s death within 24 months of the date of certification • at least one of the practitioners is a specialist practising in an area related to the illness or injury, and • the certification period has not ended for each of the certificates. If the member accesses their benefits as a result of this condition, they will no longer be held in the superannuation environment (unless they are recontributed into superannuation), meaning that any benefits which are not used will form part of the member’s personal estate on their death.

¶19-615 Estate asset: life insurance The proceeds of a life insurance policy are generally tax-free. This exemption does not apply if the policy has been transferred for consideration, but this will not usually be the case in the typical deceased estate. Proceeds of a life insurance policy which have been received by a superannuation fund from the insurer and are ultimately paid out of the fund to the deceased’s dependants and/or their estate as a death benefit may not be paid out tax-free as the tax status is dependent on who the death benefit is paid to and whether they qualify as a death benefits dependant. If a life insurance policy has a nominated beneficiary, the proceeds will not technically form part of the estate but will be distributed in accordance with the nomination. Of course, if the policy on the life of the deceased is owned by the surviving spouse, the policy is not an asset of the deceased in any event. In a small business partnership, each partner’s life may be insured so as to provide sufficient funds to

enable the deceased partner’s share to be bought out. The proceeds of such a policy would not be assessable.

¶19-620 Estate asset: shares Where shares change ownership because of the death of a shareholder, care may need to be taken to preserve the benefits of imputation credits. Under the imputation system of company taxation, shareholders receiving dividends may claim imputation credits based on the amount of tax paid at the company level. In choosing a beneficiary of franked shares, it should be borne in mind that these credits cannot, however, be claimed by non-resident individuals. The full amount of the imputation credits will be available even if the deceased dies part-way through the year. Bonus shares For CGT purposes, the normal rules for determining the date of acquisition and cost base of bonus shares (¶2-205) apply, even though the shares are issued after death. Death ignored for certain purposes Under the CGT regime, in certain situations pre-CGT assets owned by a company can be converted to post-CGT assets if there is a change in continuity of the majority shareholdings in the company. However, this does not apply where shares are simply disposed of to a natural person as part of the distribution of a deceased estate. Companies are also restricted from carrying forward losses where there has been a change of beneficial ownership. The fact that shares which the deceased owned have been transmitted to a beneficiary or an estate trustee does not amount to a change of beneficial ownership for these purposes.

¶19-625 Estate asset: accrued leave payments No income tax is payable on accrued annual or long service leave payments which become payable on the death of a taxpayer. This applies whether the payments are made directly to a beneficiary or to the estate trustee.

¶19-630 Estate asset: personal use assets and collectables According to CGT rules, if the deceased had a personal use asset or collectable, the beneficiary or estate trustee is taken to have acquired it on the date of death, and the asset retains its status in their hands. This will mean, for example, that capital losses from the subsequent sale of collectables — such as paintings, jewellery, stamps, coins or antiques — can only be offset against capital gains from similar types of assets. Capital losses from other types of personal use assets are not taken into account at all. For the CGT rules relating to personal use assets and collectables, see ¶2-340.

¶19-635 Estate asset: motor vehicles Most types of motor vehicles are exempt from CGT. This means, for example, that CGT will not apply if a beneficiary sells an inherited car. This exemption applies to: • motor vehicles designed to carry loads of less than one tonne and fewer than nine passengers • motor cycles • other similar road vehicles. Motor vehicles are, however, treated as assessable assets for the purpose of the social security assets test.

RULES THAT APPLY TO DIFFERENT TYPES OF ENTITLEMENTS UNDER WILLS ¶19-650 Different types of entitlements under wills In this section, we look at the various ways in which benefits are provided under wills and examine any special rules that apply to them.

¶19-655 Legacies A cash legacy is not assessable to the beneficiary, either as income or as a capital gain. A different rule applies if a cash legacy is given to the estate trustee instead of commission, or as a reward for services performed in administering the estate. This type of legacy is assessable income. Interest paid on a legacy is also assessable income. There can also, of course, be legacies of property, eg a gift of a particular asset. This attracts the normal tax rules, according to the nature of the asset, but see ¶19-755 for the position where gifts of property are made to charities.

¶19-660 Contingent gifts A gift may be made conditional on the beneficiary reaching a certain age, or fulfilling some other condition. This is called a contingent gift. Normally, if the condition is not fulfilled, the gift would have no effect and the proceeds would form part of the general estate. If the testator intends that the gift should pass to someone else (eg the dependants of the intended beneficiary), that will need to be specified in the will. Special rules apply to gifts to children (¶19-750).

¶19-665 Annuities An annuity is a right to receive a definite annual sum. This right may be perpetual, or for a lifetime, or for any other period. The person entitled to the annuity is called the annuitant. The amount of the annuity is assessable income to the annuitant. A trustee, in the absence of any other direction, may purchase an annuity to provide for the beneficiaries. However, if the estate trustee has purchased the annuity from a life insurance company, a proportion of the cost may be offset against the assessable amount.

¶19-670 Assets appropriated by trustee for beneficiary The will may give the trustee a power to satisfy a beneficiary’s entitlement by taking (appropriating) specific estate assets and distributing them to the beneficiary. In such a case, the normal CGT death rules (¶19-550) will apply in the same way as if the asset passed directly to the beneficiary under the will. In exercising this power, it must be remembered that the effect of those rules varies according to the CGT status of the asset. Some of the considerations are: • an asset distributed to a beneficiary on a high marginal rate will generally lead to a higher CGT liability on subsequent sale than if it were distributed to a beneficiary on a low marginal rate • the distribution of a CGT-exempt asset (such as a main residence) may be worth more than the distribution of an asset (such as land) which may give rise to CGT on subsequent disposal by the beneficiary • the distribution of a pre-CGT asset to a beneficiary may be worth more than the distribution of a postCGT asset where the market value of the land at the date of death is greater than the cost base

• if the estate has already incurred a capital loss, the disposal of an asset at a capital gain to recoup that loss may be preferable to the distribution of that asset to a beneficiary. There would normally be no stamp duty problems if the distribution is made under a power conferred in the will to appropriate a specific asset.

¶19-675 Assets subsequently acquired by trustee During the administration of the estate, the estate trustee may acquire other assets that did not originally form part of the estate. For example, estate funds might be invested in acquiring an asset, or one asset may be sold in order to fund the acquisition of another. These new assets are sometimes called “afteracquired assets”. Normally this would have no ordinary tax implications unless the trustee is carrying on a business (eg the trading stock or depreciation provisions may apply), or if the asset was acquired with a profit-making purpose (so that the profit on resale is assessable). Bonus shares received by the trustee may also be treated as assessable dividends. If the trustee acquires a new asset and sells it to a third party, the normal CGT rules apply as if the trustee was just like any other taxpayer. For example, a capital gain will arise if the proceeds exceed the cost base of the asset. However, there is an important exception to this rule where the trustee purchases a dwelling for a beneficiary (¶19-605). In regard to where the asset was subject to a life interest, see ¶19710.

¶19-680 Asset sold to beneficiary In accordance with the will, a trustee may sell an estate asset to a person who happens to be a beneficiary of other assets under the will. In this situation, the beneficiary is treated in the same way as any other third party purchaser. This means that the disposal to the beneficiary as well as a subsequent disposal by the beneficiary may be subject to CGT under the general rules (¶19-550).

¶19-685 Asset acquired under an option The will may provide that a particular person has the option of buying an estate asset. For example: • a surviving business partner may be given first option to acquire assets relevant to the business, or • a surviving co-owner may be given the option to acquire the remaining interest in the asset. If the person exercises the option, there may be CGT consequences. The transaction will be treated as a sale of the asset to the beneficiary, rather than as an inheritance. If the asset is pre-CGT, its cost to the estate will normally be its market value. If the asset is post-CGT, its cost to the estate will normally be based on the cost to the deceased.

¶19-690 Asset that has been “improved” If a person makes a post-CGT capital improvement to a pre-CGT asset, that improvement may be treated as a separate post-CGT asset if its cost exceeds certain thresholds. This may apply, for example, if a beneficiary inherits an asset from a person who died before 20 September 1985, and then makes a postCGT capital improvement. The effect will be that, if the improved asset is later sold, CGT may apply to the gain attributable to the improvement. This capital improvement rule does not apply if the improvement was made by the deceased and the improved asset passes to a beneficiary. In this case, the whole asset is simply treated as a pre-CGT asset of the deceased, and is therefore taken to have been acquired by the beneficiary at market value.

¶19-695 Assets previously held by joint tenants

Assets such as real estate are often held by two people as “joint tenants” (¶19-010). In such cases, when one of them dies, the asset automatically becomes owned solely by the surviving person. It does not fall within the deceased’s estate so this occurs no matter what the deceased’s will may say. No CGT applies at this stage. However, CGT may apply if the surviving person later disposes of the asset. For this purpose, the survivor is taken to have acquired the deceased’s interest for: • market value (if the deceased acquired their share in the asset before 20 September 1985), or • the cost base of the share to the deceased (if the deceased acquired their share after 19 September 1985). Of course, if the asset was a main residence, the CGT main residence exemption may apply (¶19-605). If there are two or more surviving joint tenants, they are taken to have acquired the asset in equal shares.

¶19-700 Entitlement under discretionary trust Under a discretionary trust, the trustee has a discretion as to the way in which income or capital (assets) is distributed to the beneficiaries (¶19-115). If the deceased set up a discretionary trust before death, the trust assets are held by the trust, not the deceased, and so do not form part of the estate. To this extent, the death does not necessarily alter entitlements, which continue unless the trust has been designed to terminate on death. However, provision will need to have been made as to the person to whom control should pass (¶19-800). If a trust is set up under the will, it is called a “testamentary trust”. For the tax treatment of the income of a testamentary trust, see ¶19-255 and ¶19-850. For a more detailed discussion of testamentary trusts, see

¶19-200.

¶19-705 Property subject to a mortgage If a beneficiary inherits a specific asset which is subject to a secured debt (eg real estate which is subject to a mortgage), the debt normally remains payable out of that asset. If the beneficiary cannot pay the debt, this may mean that the trustee will have to sell the asset, pay the debt and distribute the balance to the beneficiary. In calculating the cost base of the asset, the amount owing is taken as part of the cost of acquisition. If the testator wishes, there can be a specific provision in the will that ensures that a debt is paid out of the general estate, rather than out of the particular asset. Of course, it is always open to a beneficiary to disclaim a gift (¶19-715). This may be appropriate where the amount owing is more than the value of the asset.

¶19-710 Life estates Under a will, a person may be granted an interest in an asset, or in the income from an asset, for the period of their lifetime. After they die, the asset or income reverts to someone else. This type of grant is called a life estate, and the relevant person is called the life tenant. If a person has a life estate in certain income, that person will be assessable on that income in the ordinary way. Careful attention needs to be paid to the exact description of the entitlement in the will, as “income” may be defined in different ways, eg the net tax income may include taxable capital gains. The grant of a life estate has no automatic CGT consequences for the estate. There are also no CGT consequences for the life tenant when that person dies and the life interest comes to an end. The person to whom the property reverts is treated in the same way as a direct beneficiary. If the original willmaker died after 19 September 1985, the person may become liable to CGT on subsequent disposal. If a person is granted a life estate in a dwelling, special care may be needed to comply with the rules relating to the CGT main residence exemption (¶19-605). If a person is granted a life interest in real estate, that person would generally be classed as an owner and would therefore be liable for any land tax on the property. Correspondingly, the life tenant would also be eligible to claim any land tax exemption for the main residence. If the deceased was a life tenant, that interest will of course cease on the date of death, and the property will revert to the person entitled under the original grant. The deceased’s will is not relevant to this, as the interest forms no part of the deceased’s estate.

¶19-715 Disclaimed interests Although property or money may have been left to a beneficiary, it is open to that beneficiary to disclaim the entitlement. This will typically mean that the property or money is instead distributed to the person(s) entitled to the rest of the estate. A disclaimer may give rise to CGT complications. If the beneficiary receives payment for the disclaimer, that payment may be treated as a capital gain. If there is no payment, there is a possibility that the beneficiary will be treated as realising a capital gain based on the market value of the disclaimed benefit. Care may also need to be taken to ensure that the disclaimer does not operate as a transfer of property that would attract stamp duty. As a minimum precaution, for example, the disclaimer should be made well before the estate has been administered.

RULES THAT APPLY TO DIFFERENT TYPES OF BENEFICIARIES ¶19-750 Children as beneficiaries

Normally, if a gift is made to a beneficiary who dies before the testator, the gift is ineffective, and the proceeds form part of the general estate. Although the position may vary from state to state, there may be an exception to this rule where the gift is made to the testator’s children. If a child dies before the testator, but that child itself has children who survive the testator, then the child’s entitlement generally passes to those children. This can be overturned by a specific provision in the will. For the advantages of having a child as a beneficiary under a discretionary trust, see ¶19-855.

¶19-755 Charities and superannuation funds A person who makes a charitable gift during their lifetime can claim a tax deduction. In contrast, if the person makes a charitable gift in their will, no tax deduction is allowed. The CGT consequences of a charitable gift depend on the tax status of the organisation receiving the gift and the nature of the asset being gifted. Where an asset passes to a tax exempt body, the deceased is deemed to have disposed of the asset immediately prior to death for market value. The estate is then liable for any CGT liability. Alternatively, if the asset is gifted to a tax-deductible body, any CGT is disregarded. For further discussion, see ¶19-160. For CGT purposes, a bequest of property to a superannuation fund is treated as if it were a sale of the property to the fund at market value. If this is more than the cost base, there will be a capital gain that will be taken into account in the deceased’s date-of-death return. CGT will not arise in any event if the deceased had acquired the property before 20 September 1985.

¶19-760 Public galleries, museums and libraries Bequests of nationally significant cultural items made by will to public galleries, museums and libraries are tax deductible if they are approved under the Cultural Bequests Program and are accepted by the relevant institution. These bequests are also exempt from CGT.

¶19-765 Non-resident beneficiaries Another exception to the rule that death itself does not give rise to CGT applies where an asset passes to a non-Australian resident beneficiary (see ¶2-380 for all the exemptions for non-residents). If a non-Australian resident receives an asset from an estate that is a post-CGT asset and is not “Taxable Australian Property”, a CGT gain (or loss) will be assessed as if the deceased disposed of the asset immediately prior to death. In this case, the capital gain (or loss) must be included in the date-of-death tax return of the deceased. The term “Taxable Australian Property” includes: • an interest in Australian real estate • a CGT asset used in an Australian business • a mining, quarrying or prospecting right in Australia • an interest in a company or trust that is greater than 10% where the entity holds Australian real estate. In the converse situation, where a resident beneficiary inherits an asset from a non-resident, this is treated in the same way as an inheritance from a resident. This applies even if the asset did not have the “necessary connection” with Australia, eg where it is foreign real estate.

HOW DEATH AFFECTS A PERSON’S BUSINESS ¶19-800 Effect on business succession

If a person is involved in the running of a business, death also raises the question of how (or whether) the business is to be carried on. The effect of death will vary according to the type of business structure. Sole trader If the person was simply a sole trader, and it is intended that the business is to be effectively carried on after death, the will should specify how control and ownership of the business assets are to be allocated. Partnership In the case of a partnership, the death of one of the partners means that the partnership formally comes to an end, unless the partnership agreement provides otherwise. A partnership agreement will often contain detailed provisions to preserve the continuity of the partnership and to protect the interests of the surviving partners and the beneficiaries of the deceased partner. If it is desired that the executor or trustee participate as a business partner, this will need to be spelled out in the will, as well as being covered in the partnership agreement. Company The death of a controller of a private company does not necessarily bring the company to an end. The company continues to exist until it is wound up. Provisions covering the way that successor directors are to be appointed may be included in the company’s constitution. The will would direct who the shares in the company would pass to as, if owned by the willmaker individually, they would be a personal asset of theirs. Trust Where the business is conducted through a trust, assets are dealt with in accordance with the trust deed, not the person’s will. Depending on the terms of the deed, the trust may continue on after the person dies, or it may come to an end on that person’s death. For the tax rules that apply to trusts set up under wills, see ¶19-850.

¶19-805 Effect of death on trading stock The trading stock of a business is governed by special tax rules, and CGT generally does not apply. If the owner of a business dies, and the business has trading stock on its books, this is treated as if the owner had sold the trading stock at market value. As stock is commonly valued at below market value, the effect of dying may be that a large amount potentially becomes assessable in the date-of-death return. Correspondingly, the estate will be treated as having acquired the stock at that value. In the case of a continuing business, this result can be avoided if the executor or trustee makes the appropriate election to have the stock treated as if the death had not occurred. This election must have the consent of all the relevant beneficiaries. The trading stock must also continue to be held as trading stock of that business. If the deceased has accrued losses (¶19-910), it may sometimes be advisable not to make the election so that the losses can be absorbed. These rules apply only if the person who dies is also the person who owns the stock. They do not apply, for example, if a family company owns the business. If the business is run by a partnership, the death of a partner means that the old partnership is treated as having disposed of the stock to the new partnership at market value. However, in the case of a continuing business, this result can be avoided if the old and new partners agree that the trading stock should be treated as having been disposed of at book value. For this to apply there must be at least a 25% continuity of ownership. If a business does not continue after death, the relevant assets will lose their status as trading stock. They will therefore also lose their CGT-exempt status. This means that CGT may apply when the trustee or beneficiaries later dispose of them. In calculating this liability, the cost of the assets to the trustee or beneficiaries will generally be their market value.

¶19-810 Effect of death on depreciable assets

There are specific rules that deal with the treatment of a depreciating asset that is held by a person at death. In the first instance, the legal personal representative (ie, the executor or administrator of the estate) will hold the asset on behalf of the estate. In this instance, the termination value of the asset is the asset’s “adjustable value” at the date of death. The “adjustable value” of an asset is its cost less any decrease in its value up to the specific point in time. Therefore, there is no assessment or deduction to the deceased at this point. If the asset subsequently passes from the legal personal representative to a beneficiary, its termination value is taken to be its market value at the date of death. This may require a balancing adjustment for the estate if the adjustable value at the date of death is different to its market value at the time it is transferred to the beneficiary. In this scenario, where the termination value at the time of transfer exceeds the adjustable value, the excess is assessable. Where the termination value at the time of transfer is less than the adjustable value, there is a deduction.

ESTATE INCOME AND TESTAMENTARY TRUSTS ¶19-850 Estate income and testamentary trusts It commonly happens that the estate is earning income, eg rent may be derived from investment properties, dividends from shares, interest from investments and income from a business. In addition, the will may provide for assets to be held in trust, eg where the intended beneficiaries are minors. The tax treatment of this estate income depends on whether: • the estate has been fully administered • the beneficiaries are presently entitled. Testamentary trusts are discussed further at ¶19-165. Income derived while estate is being administered An estate is not fully administered until all the debts, annuities and legacies have been paid or provided for, and the amount left over (the “residue”) has been determined. The period from the date of death until this time is called the period of administration. Until this time, no beneficiaries are “presently entitled” in the sense that they have a complete right to immediate payment. It follows that the income derived during this period of administration is assessable to the estate, not to the beneficiaries. There can be an exception to this rule where at some stage during the administration it becomes clear to the estate trustee that part of the income will not be needed to pay for debts or legacies. In this situation, the trustee may exercise the discretion to actually pay some part of the income to the beneficiaries. If this happens, the income will be assessable to those beneficiaries, whether the estate is fully administered or not. Income derived after estate has been fully administered Income can continue to be derived by the estate even after the estate has been fully administered. This can happen, for example, where assets are being held in a testamentary trust under the will until child beneficiaries become adults, or until some other condition is satisfied. If the estate has been fully administered, the income is treated as follows: • if there is a beneficiary who is “presently entitled” to the income on the last day of the income year, and is not a minor, that beneficiary will be assessable on the income, or • if there is no such beneficiary presently entitled to the income, the income is assessable to the estate. The same applies if the beneficiary is a minor (under 18 years). Special apportionment rules apply in the particular income year in which the estate becomes fully administered. The effect of these rules is that income derived up to the day when administration was completed will be assessable to the estate, and income derived after that time will be assessable to the

beneficiary. However, for this to apply, the estate trustee and beneficiaries must all request the apportionment and be able to identify and verify those actual amounts by the striking of accounts at the completion of administration — it is not sufficient just to split up the income on a time basis. If these requirements are not complied with, beneficiaries who are presently entitled to income on the last day of the income year will be assessable on that income for the whole of the year, even though they were not presently entitled at the start of the year.

¶19-855 Tax rates on trust income If the estate is fully administered and a beneficiary is presently entitled to the income, that income is simply added to the beneficiary’s other income and taxed at the relevant marginal rate. Where the estate is not fully administered, or where no beneficiary is presently entitled, the trustee is normally taxed at the same rate as would have applied to an individual if the income were that person’s only income. This is a significant benefit — it means, for example, that the tax-free threshold will apply if the beneficiary is a resident. However, this treatment only applies for the income year in which death occurred and for the next two years. To obtain these concessional rates, the estate must make a specific request in the tax return. This request will be granted in the case of ordinary and traditional deceased estates. However, where the Commissioner suspects that tax avoidance is involved, the whole of the income may be taxed at the highest marginal tax rate. Where beneficiary is a minor Normally, minors are subject to special higher rates of tax on their investment (or “unearned”) income, and have a lower tax-free threshold than other taxpayers. However, these restrictions do not apply to income from a trust created under a will/deceased estate. In such a case, the minor is treated under the same rules as apply to adult beneficiaries. In addition, the restrictions do not apply to trust income from the investment of: • inherited property • life insurance or superannuation monies transferred to the trustee as a result of the death of the deceased, or • property transferred to the trustee by other persons who received it from the deceased’s estate (subject to conditions).

WHAT TAX RETURNS ARE NEEDED ¶19-900 Date-of-death or “terminal” tax return A tax return has to be lodged for the period from the previous 1 July up to the date of death. This is called the date-of-death (or “terminal”) return. Although it is an individual return in the name of the deceased, it is prepared and lodged by the trustee, and should be endorsed “Deceased Estate”. Any returns that the deceased has failed to lodge for earlier years must also be lodged. How tax is calculated The tax payable on a date-of-death return is calculated as if the period up to the date of death was a full tax year. The full tax-free threshold applies, and so does the full low income rebate. However, any adjustments to the tax-free threshold that are allowed under the Family Tax Assistance scheme are only allowed on a part-year basis. Rebates for dependants, sole parents or housekeepers are also allowed only on a part-year basis. If there is not enough in the estate to pay the tax, the trustee is not personally liable to make up the shortfall, unless the trustee failed to make allowance for known tax liabilities. If the deceased would not have been liable to lodge a return, the trustee is not liable to lodge a date-of-

death return. Instead, a non-lodgment advice should be sent to the ATO. Getting more time to pay The complications of administering an estate may mean that it will be difficult for the trustee to pay tax on time. To avoid late payment penalty, the trustee should formally ask the ATO for an extension of time to pay. The general practice is that if probate is not complete, the normal due date will be extended to one month after the grant of probate. There may be an extension for a “reasonable period” if the trustee needs time to sell assets in order to pay the tax. Getting an exemption for serious hardship In cases of serious hardship, the trustee may be able to obtain a full or part exemption from paying the tax due. This requires an application to a Relief Board. The Board would normally need to be convinced that payment of the tax would leave the deceased’s dependants without the means to acquire basic requirements such as food, clothing, medical supplies, accommodation or education. Objecting to the assessment In practice, it seems that the trustee can object or appeal against the assessment in the same way as the deceased could have. Getting a final tax clearance It is important that the trustee gets a clearance from the ATO that the assessed tax is “final”, and that the assessment will not be reopened at some later time. The usual procedure is to prepare a full and true statement of the deceased’s assets and liabilities, valued at the date of death, and lodge this with the return. This is not necessary if the deceased was a salary or wage earner (unless it is specifically requested by the ATO). If this is done, and the assessed tax is paid, the notice of assessment can be taken as a formal notification that the deceased’s tax liabilities up to the date of death have been satisfied. The same applies if the ATO issues a “nil” tax advice. Where estate is not being administered The ATO can issue a “default” assessment if a grant of probate or administration has not been made within six months after the death. This may happen, for example, if no one is willing to act as executor/trustee or administrator. Anyone who claims an interest in the estate can object or appeal against the assessment in the same way as the deceased could have. In extreme cases, the ATO can obtain police assistance to seize assets of the deceased in order to pay the assessed tax.

¶19-905 Estate returns for period after death A separate tax return also has to be lodged for the period from the date of death until the following 30 June. This is a trust estate return. It is made in the name of the estate, which is treated as a separate taxpayer from the deceased. Again, it is prepared and lodged by the trustee. Estate returns must continue to be lodged for each subsequent year until the estate is fully administered and is no longer deriving income. The ATO can issue a default assessment if the executor, trustee or administrator fails to lodge any of these returns.

¶19-910 Timing issues for date of death vs estate return There are important rules that decide whether particular expenses or items of income should be allocated to the deceased’s date-of-death return or to a subsequent trust estate return. Rent, interest and dividends For tax purposes, rent and interest income is derived when it is received or dealt with on the taxpayer’s behalf. Until that time it is not assessable. This means that unless the rent or interest is due, it will not be included in the deceased’s date-of-death tax return. Instead, it will be included in the relevant estate

return when it becomes due. An exception to this applies to income from certain discounted or other deferred interest securities. This is assessable as it accrues. A similar type of rule applies to dividends. These become assessable once they are paid, credited or distributed. If a dividend is merely declared, but not credited or distributed in any way at the date of death, it will not be included in the date-of-death return, and instead will be included in the relevant estate return. Any imputation credit on the dividend is dealt with in the return in which the dividend is included. Wages and salary Wages and salary are generally included in the deceased’s date-of-death return. However, if the person has done the work but payment is not received until after death, the payment would be included in the estate return. The same applies to professional income that is treated on a “cash” basis. However, if that income is properly treated on an earnings/accruals basis, the value of the amount owing at death will be included in the date-of-death return. Pay As You Go (PAYG) tax instalment deductions will generally have been made from the deceased’s wages on the basis that the deceased would work for the entire year, and a refund may therefore be appropriate for any overpayment. Amounts paid for unused annual and long service leave are tax exempt (¶19-625). Medical expenses It will commonly happen that the deceased became liable for medical expenses that are subsequently paid by the trustee after the date of death. These expenses are treated as if the deceased had actually paid them, and can therefore be taken into account in the deceased’s date-of-death return in calculating any medical expenses rebate which may be available. Costs of tax advice and return preparation Tax-related expenses that would have been deductible if they had been incurred by the deceased will be deductible in the deceased’s date-of-death return if they are incurred by the trustee. This applies, for example, to the costs of having a tax agent prepare the date-of-death return. If deceased had losses If a person had an accrued loss, that loss will lapse for tax purposes when the person dies. This means that the loss cannot be carried forward to the estate or the beneficiaries. This applies to ordinary losses as well as CGT losses. This means, for example, that if the deceased had a capital loss outstanding, neither the estate trustee nor the beneficiaries can offset that loss against any current or future capital gains that they or the estate may make. It follows that if it is known that death is imminent, it may be worth considering whether to realise some capital gains before death, so as to take advantage of unused capital losses. This may be done by selling unwanted assets. Alternatively, a gift of an asset that has appreciated in value could be made to a prospective beneficiary, with the result that this will be treated as a disposal of the asset at market value. These rules for expiry of losses also mean that care may need to be taken to avoid having the estate trustee incur a loss during the administration of the estate which will not be able to be subsequently recouped. Uncompleted contracts at date of death If the deceased had entered into a contract to sell an asset, and the transaction is completed after the date of death, CGT is calculated on the basis that the asset was sold on the date of the contract. This means that any capital gain or loss will be taken into account in the deceased’s date-of-death return. A problem can arise if such a transaction is part of a business arrangement which gives rise to ordinary income. This income will normally be assessable when the transaction is completed, and will therefore be assessable to the trustee. There may therefore be double taxation, as a capital gain from the transaction will already have been assessed to the deceased, in accordance with the rules discussed above. The

provisions that normally prevent double taxation would not seem to apply in these circumstances, as the capital gain and the ordinary income are assessed to two different taxpayers (the deceased and the trustee). If the deceased had contracted to acquire an asset, and the transaction is completed after the date of death, the asset will be taken to have been acquired by the deceased at the time of the contract. It will therefore form part of the estate in the normal way. Partnership returns Where death puts an end to a partnership (¶19-800), a partnership return should be lodged for the period up to the date of death, and a separate return for the period after death. However, if the partnership continues, only one return need be lodged with all the deceased partner’s income being attributed to the estate. Amounts owing to deceased During the administration of the estate, a trustee may receive amounts that were owing to the deceased at the date of death. These amounts are treated as assessable income of the estate if they would have been assessable to the deceased if received during their lifetime. Example The deceased, Peter, was a partner in a firm of accountants and was entitled to one-quarter of its profits. The firm pays the estate trustee an amount representing Peter’s share of profits attributable to work outstanding at the date of death. This amount will be assessable to the trustee, as it would have been assessable to Peter if it had been paid during Peter’s lifetime.

This rule does not apply to payments of accrued leave, which are tax exempt (¶19-625). Nor does it apply where the deceased used an accruals or earnings form of accounting — in this situation, the income would have been included in the deceased’s date-of-death return. In the case of bad debts, it is preferable for these to have been written off before death so as to ensure that a deduction can be claimed. In the converse situation, where the deceased dies owing debts, and without assets, those debts could be treated as bad debts that could be deductible to the creditor.

HOW DEATH AFFECTS OTHER TAXES AND BENEFITS ¶19-950 Death and liability for duties Duties are typically imposed by the states/territories on transfers of assets, based on the value of the asset. However, the rates applying on transfers to estate trustees or beneficiaries under the will are generally nominal. In contrast, full rates will generally apply if an asset is transferred to the beneficiary while the deceased is still alive, or if an asset is sold to a beneficiary who is not entitled to that asset under the will. Where there is a variation of the terms of the will, particularly where a deed of arrangement is involved, care must also be taken to ensure that duty is not unnecessarily attracted. It may be that the asset that is transferred did not form part of the original estate. This can happen, for example, where the asset consists of bonus shares that are received after death, or the asset has been purchased by the trustee from the proceeds of sale of an estate asset. Normally, only nominal rates of duty would apply when these assets are transferred to beneficiaries under the will, though the practice differs somewhat depending on the state/territory. Duty is not payable on the setting up of a testamentary trust.

¶19-955 Death and liability for land tax Land tax is typically levied on the unimproved value of a person’s real estate. There are various exemptions that vary between states/territories, but concessional treatment applies for principal residences. Typically, there is provision for this concessional treatment to continue for a period after

death, subject to various conditions. Where land is under the control of the trustee of the estate, the trustee would typically be liable to lodge land tax returns on the same basis as the deceased. Where a life tenant is in possession of the land, they will normally be considered the owner for land tax purposes, and would therefore be liable for any land tax payable.

¶19-960 Death and social security When a person dies, social security entitlements may change in various ways. These changes may occur because: • the death puts an end to the deceased’s entitlements and obligations • the death gives rise to specific social security entitlements, such as Bereavement Allowance • the death alters the dependent status of surviving family members, giving rise to new entitlements to social security benefits, or • entitlements under the will may increase, or (more typically) reduce, other persons’ capacities to satisfy the pension assets and income tests for various benefits. Deceased’s entitlements and obligations cease The most obvious change is that the deceased person’s entitlement to social security will cease. Any back-payment of outstanding entitlements will be paid to the person whom Centrelink considers is best entitled to it. Death will also mean that the person stops becoming liable to pay Child Support. Bereavement Allowance may be payable The death of a pensioner may mean that a Bereavement Allowance may be payable to the surviving partner for up to 14 weeks. A lump sum bereavement payment may also be payable to surviving family members who are already entitled to specified allowances. Survivors’ new status may give rise to new entitlements The death may also give rise to new entitlements to social security benefits for dependants of the deceased. For example: • a surviving spouse may become entitled to a Widow Allowance (¶6-270) • a surviving parent with a qualifying child may become entitled to Parenting Payment (¶6-240) • a Double Orphan Pension may be payable for a surviving child if the other parent is dead, incarcerated or has disappeared (¶6-300). This pension is not subject to the assets and income tests.

RATES AND TABLES Introduction

¶20-000

Income tax rates Resident individuals

¶20-010

Medicare levy

¶20-020

Medicare levy surcharge

¶20-025

Non-resident individuals

¶20-030

Minors

¶20-035

Personal tax offsets and rebates

¶20-040

Senior Australians and pensioner tax offset (SAPTO)

¶20-043

Low income tax offset

¶20-045

Low and middle income tax offset

¶20-046

Superannuation funds, ADFs and PSTs

¶20-060

Companies and life insurance companies

¶20-070

Small business income tax offset

¶20-075

Higher Education Loan Program

¶20-080

Employment-related payments Employment termination payments

¶20-100

Genuine redundancy and early retirement scheme payments

¶20-110

Unused annual leave payment rules

¶20-115

Unused long service leave payment rules

¶20-120

Capital gains Capital gains tax rate

¶20-150

CGT index numbers

¶20-160

Fringe benefits Fringe benefits tax rate

¶20-200

Statutory fractions for car benefit valuation

¶20-210

Interest rates for car and loan fringe benefits

¶20-220

Pension tables Minimum annual pension payment percentages — account-based pensions ¶20-240 Australian life tables

¶20-250

Minimum and maximum pension valuation factors

¶20-260

Payment factors — term allocated pensions

¶20-270

Indexation Average weekly ordinary time earnings (AWOTE)

¶20-290

Payment of superannuation benefits Taxation of superannuation benefits

¶20-300

Taxation of superannuation death benefits

¶20-305

Superannuation contributions Concessional contributions cap

¶20-310

Non-concessional contributions cap

¶20-320

Spouse contributions

¶20-330

Government co-contributions

¶20-340

Superannuation guarantee charge Superannuation guarantee charge percentage

¶20-400

Maximum contribution base

¶20-410

Social security Energy supplement

¶20-450

Maximum benefit entitlement for pensions

¶20-460

Maximum benefit entitlement for allowances

¶20-470

Basic income test for pensions

¶20-530

Basic income test for allowances

¶20-540

Deeming rates and thresholds

¶20-545

Basic assets test for home owners

¶20-550

Basic assets test for non-home owners

¶20-560

Family Tax Benefit Part A rates of payment

¶20-570

Family Tax Benefit Part A income test limits

¶20-572

Family Tax Benefit Part B rates of payment

¶20-574

Paid parental leave

¶20-578

Aged care

¶20-580

¶20-000 Introduction This chapter outlines the taxation, superannuation and social security rates and other information often used in financial planning. Where available, rates and thresholds for 2020/21 have been included.

INCOME TAX RATES ¶20-010 Resident individuals The general rates of tax applicable to resident individual taxpayers for 2020/21 are as follows: Taxable income (column 1)

Tax on column 1

($)

($)

18,200

Nil

% on excess (marginal rate)

19

37,000

 3,572

32.5

90,000

20,797

37

180,000

54,097

45

Further changes to the income tax rates and thresholds to reduce the income tax for individuals will take effect from the 2022/23 income year.

¶20-020 Medicare levy Resident individuals are liable to pay a Medicare levy (¶1-075) based on the amount of their taxable income for the income year. The Medicare levy rate for the 2020/21 income year is 2% of taxable income. Low income earner No Medicare levy is payable where a person’s taxable income does not exceed a certain threshold amount. The Medicare levy low income thresholds for 2020/21 are not available at the time of writing. For 2019/20, the threshold amount for individuals other than certain senior Australians and pensioners (see below) is $22,801. Where taxable income for 2019/20 is more than $22,801 but does not exceed $28,502, the levy is shaded in at the rate of 10% of the excess over $22,801. For individuals who qualify for the Senior Australians and Pensioners Tax Offset (¶1-355), the threshold amount is $36,056. A higher “family income threshold” applies if a taxpayer is married (defined to include de facto and samesex couples) on the last day of the income year or would be entitled to a dependant (invalid and carer) tax offset and those who are notional entitled to a rebate for a dependant child or student (including sole parents). In those cases, no levy is payable if the family income does not exceed $38,474; the threshold amount is increased by $3,533 for each dependent child or student for whom the taxpayer or the taxpayer’s spouse was entitled to a notional dependants rebate. For taxpayers who are eligible for the Senior Australians and Pensioners Tax Offset, the family income threshold is $50,191, increased by $3,533 for each dependant. Income thresholds and shading-in ranges The following rates apply for the 2019/20 income year.

2019/20 income thresholds and shading-in ranges Category of taxpayer

No levy payable if taxable income (or family income) does not exceed…

Reduced levy payable if taxable income (or family income) is within the range (inclusive)…

Ordinary rate of levy payable where taxable income (or family income) is or above…

(col 1)

(col 2)

(col 3)

(col 4)

Individual taxpayer

$22,801

$22,802–$28,501

$28,502

0

$38,474

$38,475–$48,092

$48,093

1

$42,007

$42,008–$52,508

$52,509

2

$45,540

$45,541–$56,924

$56,925

3

$49,073

$49,074–$61,340

$61,341

4

$52,606

$52,607–$65,756

$65,757

5

$56,139#

$56,140 #–$70,172 †

$70,173

Families* with the following children and/or students:

* These figures also apply to taxpayers who are entitled to a dependant (invalid and carer) tax offset and those who are notionally entitled to a rebate for a dependant child or student (including sole parents). # Where there are more than five dependent children and/or students, add $3,533 for each extra child or student. † Where there are more than five dependent children and/or students, add $4,416 for each extra child or student. Senior Australians and pensioners Individuals who are not liable to tax because they qualify for the Senior Australians and Pensioner’s Tax Offset (SAPTO) are also not liable for the Medicare levy. The 2019/20 Medicare levy thresholds and phase-in limits for SAPTO are listed in the table below. Class of people

Medicare levy low-income threshold (no Medicare levy payable at or below this level)

Phase-in limit (level above which the Medicare levy is payable at the full rate)

$36,056

$45,069

Senior Australians and eligible pensioners

¶20-025 Medicare levy surcharge Individual taxpayers on higher incomes who do not have adequate private patient hospital insurance for themselves and their dependants may be liable for an additional Medicare levy surcharge (MLS). MLS is levied at the rate of 1%, 1.25% or 1.5% of a taxpayer’s taxable income and reportable fringe benefits depending on theirs or their family’s “income for surcharge purposes” (see ¶1-075). The table below indicates how the MLS rules apply in conjunction with the private health insurance rebate rules for 2019/20. These rebates continue to apply up to 31 March 2021 as they were not changed on 1 April 2020. Income Singles

$0–$90,000

$90,001–$105,000

$105,001–$140,000

$140,001 and over

Families*

$0–$180,000

$180,001–$210,000

$210,001–$280,000

$280,001 and over

Private health insurance rebate Base Tier

Tier 1

Tier 2

Tier 3

Under 65 years of age

25.059%#

16.706%#

8.352%#

0%

65–69 years of age

29.236%#

20.883%#

12.529%#

0%

70 years of age and over

33.413%#

25.059%#

16.706%#

0%

1.25%

1.5%

Medicare levy surcharge Percentage rate

0%

1%

* The families’ threshold is increased by $1,500 for each dependent child after the first. Families include couples and single parent families. #

This rebate percentage applies from 1 April 2019 to 31 March 2021.

¶20-030 Non-resident individuals The rates of tax applicable to prescribed non-resident individual taxpayers for the 2020/21 are as follows:

Taxable income (column 1)

Tax on column 1

% on excess (marginal rate)

($)

($)

Nil

Nil

32.5

 90,000

29,250

37

180,000

62,550

45

The above scale enables the calculation of gross tax payable by prescribed non-resident individuals (¶1550). A “prescribed non-resident” is a person who at all times during the income year was a non-resident, other than a person in receipt of a taxable Australian social security or taxable Australian veterans’ entitlement pension. Prescribed non-residents pay tax on the very first dollar of taxable income. A non-resident who does not qualify as a prescribed non-resident is taxed at the same rates as a resident.

¶20-035 Minors The following are the special rates of tax applicable under the Income Tax Assessment Act 1936 (ITAA36) Div 6AA to eligible taxable income of a minor (¶1-070) for 2020/21. Resident minors Where eligible taxable income is $416 or less, the special rates do not apply. The general rates applicable to resident individuals simply apply to the whole of the taxable income. Where eligible taxable income exceeds $416 but is less than $1,308, the tax on the eligible taxable income is the greater of: (i) 66% of the excess over $416, and (ii) the difference between tax on the whole of the taxable income and tax on the taxable income other than the eligible taxable income. Where eligible taxable income exceeds $1,307, tax is payable on the whole of the eligible taxable income at the rate of 45%. Minors with “unearned income” (¶1-070) cannot apply the low income tax offset or the low and middle income tax offset against this income. Minors with income from working can, however, apply these offsets to their wages. Prescribed non-resident minors Where eligible taxable income does not exceed $416, the tax payable on that income is the greater of: (i) 32.5% of the eligible taxable income, and (ii) the difference between tax on the total taxable income and tax on the taxable income other than the eligible taxable income, using in both cases the rates applicable to prescribed non-residents. Where eligible taxable income exceeds $416 but does not exceed $663, the tax payable on that income is the greater of: (i) $135.20 plus 66% of the excess over $416, and (ii) the difference between tax on the total taxable income and tax on the taxable income other than the eligible taxable income, using in both cases the rates applicable to prescribed non-residents. Where eligible taxable income exceeds $663, tax is payable on the whole of the eligible taxable income at the rate of 45%.

¶20-040 Personal tax offsets and rebates The standard rebate amounts for 2020/21 are as follows: Tax offset/rebate Dependant (Invalid and Carer) Tax Offset (DICTO)

Amount

Cut out threshold

$2,816

$11,546

Zone rebates The following zone rebates are available: • Ordinary Zone A: $338 plus 50% of the relevant rebate amount • Special Zone A: $1,173 plus 50% of the relevant rebate amount • Ordinary Zone B: $57 plus 20% of the relevant rebate amount • Special Zone B: $1,173 plus 50% of the relevant rebate amount. The relevant rebate amount refers to the following rebates to which the taxpayer is notionally entitled: Tax offset/rebate

Amount

Cut out threshold

DICTO

$2,816

$11,546

Sole parent

$1,607

N/A

Child less than 21 years of age (not student) — for first such child

$376

$1,786

Child less than 21 years of age (not student) — for each successive child

$282

$1,410

Student

$376

$1,786

¶20-043 Senior Australians and pensioner tax offset (SAPTO) For details about the Senior Australians and pensioner tax offset (SAPTO), see ¶1-355. The SAPTO amounts for the 2020/21 year are as follows: Age and family situation

Offset level

Shade-out threshold

Cut-out threshold

Single

$2,230

$32,279

$50,119

Couple (each)

$1,602

$28,974

$41,790

Couple separated because of illness (each)

$2,040

$31,279

$47,599

¶20-045 Low income tax offset Resident individuals are entitled to a “low income” offset (ITAA36 s 159H; 159N). The maximum offset for the 2020/21 year is $445 and applies in full to taxable incomes of $37,000 or less. The offset is reduced by one and a half cents for every dollar by which the taxpayer’s taxable income exceeds $37,000 with the result that the offset phases out entirely at a taxable income of $66,667.

¶20-046 Low and middle income tax offset A low and middle income tax offset (LMITO) is available in the 2020/21 year to resident individual

taxpayers and certain trustees, with relevant income that does not exceed $126,000. The maximum amount of the offset is $1,080 and the amount varies according to income levels as follows: • for taxpayers with income not exceeding $37,000 — $255 • for taxpayers with income exceeding $37,000 but not exceeding $48,000 — $255 plus 7.5% of the amount of the income that exceeds $37,000 • for taxpayers with income exceeding $48,000 but not exceeding $90,000 — $1,080, and • for taxpayers with income exceeding $90,000 — $1,080 less 3% of the amount of the income that exceeds $90,000. The LMITO is in addition to the low income offset.

¶20-060 Superannuation funds, ADFs and PSTs The following rates of tax apply to superannuation funds, approved deposit funds (ADFs) and pooled superannuation trusts (PSTs) (¶4-300) for the 2020/21 income year. Type of fund

Tax rate

Complying superannuation funds Assessed on income, including realised capital gains and taxable contributions

15%

Assessed on special income

45%

Non-complying superannuation funds Assessed on income, including realised capital gains and taxable contributions

45%

Complying ADFs Assessed on income, including realised capital gains and taxable contributions

15%

Assessed on special income

45%

Non-complying ADFs Assessed on income, including realised capital gains and taxable contributions

45%

PSTs Assessed on income, including realised capital gains and any taxable contributions transferred from investing funds

15%

Assessed on special income

45%

*Superannuation funds which receive no-TFN contributions income are required to pay additional tax on such income, subject to the tax rebate if a TFN is subsequently provided.

¶20-070 Companies and life insurance companies The following table shows the rates of tax applicable to companies and life insurance companies for the 2020/21 income year. TYPE OF COMPANY

TAX RATE

PRIVATE COMPANIES • Private companies (other than life insurance companies) that are not base rate entities (BREs) .................................... • Private companies (other than life insurance companies) that are

30%

BREs....................................

26%1

PUBLIC COMPANIES • Public companies (other than life insurance companies) that are not BREs ....................................

30%

• Public companies (other than life insurance companies) that are BREs....................................

26%1

LIFE INSURANCE COMPANIES • Ordinary class of taxable income ....................................

30%

• Complying superannuation class of taxable income ....................................

15%

RSA PROVIDERS • Companies (other than life insurance companies) that are RSA providers –

Standard component of taxable income ....................................

30%

–

RSA component of taxable income ....................................

15%

NON-PROFIT COMPANIES • First $416 of taxable income ....................................

Nil

• Shade-in above $416 to $832 for BREs; otherwise $416 to $915 ....................................

55%

• Taxable income above shade-in range of $832 for BREs ....................................

26%1

• Taxable income above shade-in range of $915 for other non-profit companies....................................

30%

POOLED DEVELOPMENT FUNDS (PDFs) • Companies that are PDFs throughout the year of income: –

on SME income component ....................................

15%

–

on unregulated investment component ....................................

25%

• Companies that become PDFs during the year of income and are still PDFs at the end of the year: –

on SME income component ....................................

15%

–

on unregulated investment component ....................................

25%

–

on so much of the taxable income as exceeds the PDF component (i) if a BRE .................................... (ii) if not a BRE ....................................

26%  30% 

CREDIT UNIONS – – –

Small credit unions (taxable income less than $50,000) that are BREs....................................

26%1

Small credit unions (taxable income less than $50,000) that are not BREs ....................................

30%

Medium credit unions (taxable income of $50,000 to $149,999) that are BREs ....................................

41.25%

–

– –

Medium credit unions (taxable income of $50,000 to $149,999) that are not BREs ....................................

45%

Large credit unions (taxable income of $150,000 and above) that are BREs ....................................

26%1

Large credit unions (taxable income of $150,000 and above) that are not BREs ....................................

30%

1. This rate applies to base rate entities with an annual aggregated turnover of less than $50m. An entity is also only a base rate entity if no more than 80% of its assessable income is passive income.

¶20-075 Small business income tax offset For 2020/21, individuals who receive business income from a small business entity, other than via a company, are entitled to a discount of 13% of the income tax payable on that business income up to a maximum of $1,000 a year. The rate of the discount will increase to 16% in 2021/22. This applies for entities with an annual aggregated turnover of less than $5m.

¶20-080 Higher Education Loan Program The income thresholds and the repayment rates for 2020/21 are as follows: 2020/21 repayment income

Rate of repayment*

Below $46,620

Nil

$46,620–$53,286

1.0%

$53,287–$57,055

2.0%

$57,056–$60,479

2.5%

$60,480–$64,108

3.0%

$64,109–$67,954

3.5%

$67,955–$72,031

4.0%

$72,032–$76,354

4.5%

$76,355–$80,395

5.0%

$80,396–$85,792

5.5%

$85,793–$90,939

6.0%

$90,940–$96,396

6.5%

$96,397–$102,179

7.0%

$102,180–$108,309

7.5%

$108,310–$114,707

8.0%

$114,708–$121,698

8.5%

$121,699–$128,999

9.0%

$129,000–$136,739

9.5%

$136,740 and above

10%

* The repayment rate is applied to the repayment income. Repayment income is the sum of the taxpayer’s taxable income, total net investment loss, ie from financial investments (shares, interests in managed investment schemes (including forestry schemes), rights and options, and like investments), and from rental properties, reportable fringe benefits, exempt foreign employment income for the year, and

reportable superannuation contributions.

See ¶13-400 for details of HELP.

EMPLOYMENT-RELATED PAYMENTS ¶20-100 Employment termination payments For a general explanation of employment termination payments (ETPs), see ¶14-000 onwards. For a discussion of their taxation treatment, see ¶1-285. Component

Tax treatment

Tax-free component

Not assessable income and not exempt income

Taxable component

Preservation age and over • amount up to applicable cap amount (see the table below) — taxed at a maximum rate of 15% • amount over the applicable cap amount — taxed at top marginal rate (45%) Below preservation age • amount up to the applicable cap amount — taxed at a maximum rate of 30% • amount over the applicable cap amount — taxed at top marginal rate

Medicare levy (2%) is added to the applicable tax rate. Note: while the levy applies to lump sum termination payments to the extent that the individual’s taxable income (including the lump sum) exceeds $180,000, a tax offset mechanism ensures that the tax rate applying to the lump sum payment does not exceed the relevant maximum tax rate.

Applicable cap amount — life benefit termination payment

Income year

ETP cap amount (indexed yearly)

Whole-of-income cap (not indexed)

2014/15

$185,000

$180,000

2015/16

$195,000

$180,000

2016/17

$195,000

$180,000

2017/18

$200,000

$180,000

2018/19

$205,000

$180,000

2019/20

$210,000

$180,000

2020/21

$215,000

$180,000

¶20-110 Genuine redundancy and early retirement scheme payments The tax-free thresholds for genuine redundancy and early retirement scheme payments are contained in the table below. Income year

Base amount

For each completed year of service

2017/18

$10,155

$5,078

2018/19

$10,399

$5,200

2019/20

$10,638

$5,320

2020/21

$10,989

$5,496

The tax-free amount of a redundancy payment for 2020/21 is calculated as: $10,989 + ($5,496 × completed years of service)

¶20-115 Unused annual leave payment rules A lump sum payment to a taxpayer in lieu of unused annual leave in consequence of retirement from or termination of any office or employment may be, in certain circumstances, subject to concessional tax treatment which limits the maximum rate of tax payable on all or certain parts of the payment. The table below sets out the applicable rates of tax. Period of accrual of leave

Assessable portion

Maximum rate

– accrual before 18 August 1993

100%

30%

– accrual on or after 18 August 1993

100%

Marginal

Bona fide redundancy amount, early retirement scheme amount or invalidity amount paid on or after 18 August 1993

100%

30%

General retirement or termination:

The assessable portions are aggregated with other assessable income of the taxpayer, and the maximum rates are effected by way of a rebate if the tax (as calculated in the normal manner) attributable to those portions exceeds the relevant maximum rates. Medicare levy and levy surcharge may be added to whichever rate is applicable.

¶20-120 Unused long service leave payment rules A lump sum payment to a taxpayer in lieu of unused long service leave in consequence of retirement from or termination of any office or employment may be, in certain circumstances, subject to tax concessions which limits the maximum rate of tax payable on all or certain parts of the payment. The table below sets out the applicable rates of tax. Period of accrual of leave

Assessable portion

Maximum rate

5%

Marginal

– accrual 16 August 1978 to 17 August 1993

100%

30%

– accrual on or after 18 August 1993

100%

Marginal

5%

Marginal

100%

30%

General retirement or termination: – accrual before 16 August 1978

Bona fide redundancy amount, early retirement scheme amount or invalidity amount: – accrual before 16 August 1978 – accrual on or after 16 August 1978

The assessable portions are aggregated with other assessable income of the taxpayer, and the maximum rates are effected by way of a rebate if the tax (as calculated in the normal manner) attributable to those portions exceeds the relevant maximum rates. Medicare levy and levy surcharge may be added to whichever rate is applicable.

CAPITAL GAINS

¶20-150 Capital gains tax rate A taxpayer whose assessable income includes a net capital gain under the capital gains tax (CGT) provisions is generally taxed at ordinary rates on the net gain. Individuals and trusts can discount by 50% their capital gains on assets owned for at least 12 months. An additional 10% discount is available for resident individuals investing in affordable housing. The discount for superannuation funds is one-third. The gain to be discounted is worked out without indexation of the cost base of the asset. If the asset was acquired before 21 September 1999, the individual, trust or superannuation fund can alternatively calculate a capital gain on the basis of the asset’s indexed cost base, but with indexation frozen at 30 September 1999. Companies are not entitled to discount their capital gains but are entitled to use the “frozen indexation” basis for assets acquired before 21 September 1999.

¶20-160 CGT index numbers If a CGT asset acquired on or before 11.45 am EST on 21 September 1999 was held for 12 months or more, the elements that comprised its cost base were indexed by reference to the Consumer Price Index (CPI) for the purposes of calculating the amount of capital gain (but not capital loss) that arose from the CGT event. Cost base indexation is frozen from 30 September 1999. However, the CPI numbers for the December 1999 and March and June 2000 quarters are also required for the limited purpose of performing certain notional calculations relating to the averaging of capital gains for the 1999/2000 year only. The index numbers below have been extracted from official publications of the Australian Bureau of Statistics. From the September 2012 quarter, the index numbers are calculated on a new index reference period of 2011/12. As a result, the index numbers for each index series have been reset to 100.0 for the 2011/12 year. The index numbers are reproduced below. Year

Quarterly CPI number March

June

September December

1985

—

—

39.7

40.5

1986

41.4

42.1

43.2

44.4

1987

45.3

46.0

46.8

47.6

1988

48.4

49.3

50.2

51.2

1989

51.7

53.0

54.2

55.2

1990

56.2

57.1

57.5

59.0

1991

58.9

59.0

59.3

59.9

1992

59.9

59.7

59.8

60.1

1993

60.6

60.8

61.1

61.2

1994

61.5

61.9

62.3

62.8

1995

63.8

64.7

65.5

66.0

1996

66.2

66.7

66.9

67.0

1997

67.1

66.9

66.6

66.8

1998

67.0

67.4

67.5

67.8

1999

67.8

68.1

68.7

69.1

2000

69.7

70.2

—

—

FRINGE BENEFITS ¶20-200 Fringe benefits tax rate For the fringe benefits tax (FBT) year commencing 1 April 2020, the rate of FBT is 47% and is calculated on the tax-inclusive value of the fringe benefits provided in the year. A FBT gross-up rate of 2.0802 applies to fringe benefits provided to employees which have been eligible to an input tax credit under the GST regime. A FBT gross-up factor of 1.8868 applies to fringe benefits which do not attract an input tax credit.

¶20-210 Statutory fractions for car benefit valuation Section 9(1) of the Fringe Benefits Tax Assessment Act 1986 sets out the formula that applies to determine the taxable value of a car fringe benefit where the employer has not elected to use the operating cost valuation method (¶3-410). The statutory fraction component of the formula is 0.2 regardless of the number of kilometres travelled in the year.

¶20-220 Interest rates for car and loan fringe benefits The taxable value of a fringe benefit provided by way of a loan and a car fringe benefit where an employer chooses to value the benefit using the operating cost method is determined by reference to a notional amount of interest (¶3-440). The notional rate of interest is the benchmark rate. The benchmark interest rate for the FBT year which commenced on 1 April 2020 is 4.8% pa.

PENSION TABLES ¶20-240 Minimum annual pension payment percentages — account-based pensions The SISR percentage factors are used to calculate the minimum pension payments for account-based income streams such as allocated pensions that commence on or after 20 September 2007 (¶16-510). For pensions that commenced between 1 July 2007 and 19 September 2007, providers can choose to use these percentage factors or the existing pension valuation factors (PVFs) for allocated pensions (¶20260). As a result of COVID-19, the minimum payment amounts for account-based pensions (and for the equivalent annuity products) were reduced by half for the 2019/20 and 2020/21 financial years (The Coronavirus Economic Response Package Omnibus Act 2020, Sch 10). The percentage factors are as follows: Age

Reduced percentage factor for 2019/20 and 2020/21

Normal percentage factor for 2013/14–2018/19

Under 65

2%

4%

65–74

2.5%

5%

75–79

3%

6%

80–84

3.5%

7%

85–89

4.5%

9%

90–94

5.5%

11%

95 and above

7%

14%

¶20-250 Australian life tables When determining the deductible amount of an annuity or pension using the formula in ITAA36 s 27H(2) (ie superannuation pensions which commenced before 1 July 2007) and non-superannuation annuities, a person’s life expectation factor is ascertained from the applicable Life Tables prepared by the Australian Government Actuary (AGA), based on when the annuity or pension first commenced (Income Tax Assessment (1936 Act) Regulation 2015, reg 9) (¶16-740). • 2015–17 Tables: commenced to be payable on or after 1 January 2020 • 2010–12 Tables: commenced to be payable on or after 1 January 2015 • 2005–07 Tables: commenced to be payable on or after 1 January 2010 • 2000–02 Tables: commenced to be payable on or after 1 January 2005 • 1995–97 Tables: commenced to be payable on or after 1 January 2000 to 31 December 2004 (inclusive). If purchased between 20 September 2004 and 31 December 2004, either the 1995–97 or the 2000–02 Life Expectancy Table can be used • 1990–92 Tables: commenced to be payable on or after 1 January 1996 • 1985–87 Tables: commenced to be payable on or after 1 May 1993 but before 1 January 1996 • 1980–82 Tables: commenced to be payable on or after 1 September 1988 but before 1 May 1993, and • 1975–77 Tables: commenced to be payable before 1 September 1988. The following tables show the life expectancy of males and females aged between 45 and 70 under each of the prescribed Life Expectancy Tables. Age when annuity or pension commenced

2015–17 tables

2010–12 tables

2005–07 tables

2000–02 tables

1995–97 tables

1990–92 tables

1985–87 tables

M

M

M

M

M

M

M

F

F

F

F

F

F

45

37.43 40.88 36.81 40.41 36.03 39.90 34.98 39.23 33.32 37.81 32.01 37.00 30.76

46

36.50 39.92 35.88 39.45 35.10 38.95 34.06 38.28 32.30 36.86 31.09 36.05 29.85

47

35.58 38.97 34.95 38.50 34.18 38.00 33.13 37.33 31.38 35.92 30.18 35.11 28.94

48

34.66 38.03 34.03 37.56 33.26 37.05 32.22 36.39 30.46 34.98 29.27 34.18 28.04

49

33.75 37.08 33.11 36.61 32.34 36.11 31.30 35.45 29.55 34.04 28.37 33.25 27.16

50

32.84 36.14 32.20 35.67 31.43 35.17 30.39 34.51 28.64 33.11 27.48 32.32 26.28

51

31.93 35.21 31.29 34.74 30.53 34.24 29.49 33.58 27.74 32.18 26.59 31.40 25.41

52

31.03 34.27 30.38 33.80 29.63 33.31 28.59 32.66 26.85 31.26 25.71 30.49 24.55

53

30.13 33.34 29.49 32.87 28.73 32.38 27.69 31.73 25.97 30.34 24.84 29.58 23.70

54

29.24 32.42 28.59 31.95 27.84 31.45 26.80 30.82 25.09 29.43 23.98 28.68 22.86

55

28.35 31.49 27.71 31.02 26.95 30.53 25.92 29.91 24.22 28.53 23.13 27.78 22.04

56

27.47 30.57 26.83 30.10 26.08 29.61 25.05 29.00 23.36 27.63 22.30 26.90 21.23

57

26.60 29.66 25.95 29.19 25.20 28.70 24.19 28.10 22.52 26.74 21.47 26.02 20.44

58

25.73 28.75 25.09 28.28 24.34 27.79 23.34 27.21 21.68 25.86 20.66 25.14 19.65

59

24.87 27.84 24.22 27.37 23.48 26.89 22.49 26.32 20.86 24.98 19.87 24.27 18.89

60

24.02 26.93 23.37 26.47 22.63 26.00 21.66 25.44 20.05 24.11 19.09 23.42 18.13

61

23.17 26.03 22.52 25.57 21.79 25.11 20.84 24.57 19.25 23.25 18.32 22.57 17.39

62

22.33 25.14 21.68 24.68 20.96 24.23 20.04 23.71 18.46 22.39 17.57 21.72 16.67

63

21.50 24.24 20.85 23.80 20.14 23.35 19.24 22.85 17.70 21.54 16.83 20.89 15.96

64

20.67 23.36 20.03 22.92 19.34 22.48 18.46 22.00 16.94 20.70 16.12 20.07 15.27

65

19.86 22.47 19.22 22.05 18.54 21.62 17.70 21.15 16.21 19.88 15.41 19.26 14.60

66

19.04 21.60 18.41 21.18 17.76 20.76 16.95 20.32 15.49 19.06 14.73 18.45 13.93

67

18.24 20.73 17.62 20.33 16.99 19.92 16.21 19.49 14.79 18.25 14.06 17.66 13.29

68

17.45 19.87 16.84 19.48 16.24 19.08 15.48 18.67 14.11 17.46 13.40 16.89 12.66

69

16.67 19.02 16.07 18.64 15.49 18.24 14.78 17.87 13.44 16.67 12.76 16.12 12.05

70

15.90 18.18 15.31 17.80 14.76 17.42 14.08 17.08 12.80 15.90 12.14 15.37 11.46

Source: Extracts from Life Expectancy Tables published by Australian Government Actuary

¶20-260 Minimum and maximum pension valuation factors The minimum and maximum annual payment amounts for account-based pensions and allocated annuities are worked out in accordance with the formula in SISR Sch 1A, as below:  AB   PVF  where: AB means the amount of the annuity account balance or pension account balance (as the case may be) on 1 July in the financial year in which the payments are made (or on the commencement day if the payments commenced in that year), and PVF means the maximum pension valuation factor set out in the second column, or the minimum pension valuation factor set out in the third column (as the case may be) of the table below. The amount calculated under the formula is rounded to the nearest $10. In the first year of an allocated annuity or pension, the maximum or minimum limit is calculated proportionally to the number of days in the financial year that include and follow the “commencement day” (ie the first day of the period to which the first payment of the annuity or pension relates). For pensions that commenced between 1 July 2007 and 19 September 2007, the following PVFs may be used or the percentage factors at ¶20-240 may be used. From 20 September 2007, the percentage factors at ¶20-240 apply. Age of beneficiary

Maximum pension valuation factor

Minimum pension valuation factor

45

12

24.2

46

12

24.0

47

12

23.7

48

12

23.4

49

12

23.1

50

12

22.8

51

11.9

22.5

52

11.8

22.2

53

11.8

21.8

54

11.7

21.5

55

11.5

21.1

56

11.4

20.8

57

11.3

20.4

58

11.2

20.1

59

11.0

19.7

60

10.9

19.3

61

10.7

18.9

62

10.5

18.5

63

10.3

18.1

64

10.1

17.7

65

9.9

17.3

66

9.6

16.8

67

9.3

16.4

68

9.1

16.0

69

8.7

15.5

70

8.4

15.1

71

8.0

14.6

72

7.6

14.2

73

7.2

13.7

74

6.7

13.3

75

6.2

12.8

76

5.7

12.3

77

5.1

11.9

78

4.5

11.4

79

3.8

10.9

80

3.1

10.5

81

2.3

10.0

82

1.4

9.6

83

1

9.1

84

1

8.7

85

1

8.3

86

1

7.9

87

1

7.5

88

1

7.2

89

1

6.9

90

1

6.6

91

1

6.3

92

1

6.0

93

1

5.8

94

1

5.5

95

1

5.3

96

1

5.1

97

1

4.9

98

1

4.7

99

1

4.5

100 or more

1

4.4

¶20-270 Payment factors — term allocated pensions For a term allocated pension (or annuity), the total amount of the payments to be made in a year is determined in accordance with the following formula: AB  PF  where: AB is the account balance: • on 1 July in the financial year in which the payment is made • if that year is the year in which the term allocated pension or annuity commences — on the commencement day. PF means the payment factor as set out in SISR Sch 6. The PF is rounded to the nearest whole as follows: (a) if the commencement day of the pension or annuity is on or after 1 January in a financial year — rounded up to the nearest whole year (b) if the commencement day is on or before 31 December in a financial year — rounded down to the nearest whole year. Term remaining (years)

Payment factor

Term remaining (years)

Payment factor

70 or more

26.00

35

20.00

69

25.91

34

19.70

68

25.82

33

19.39

67

25.72

32

19.07

66

25.62

31

18.74

65

25.52

30

18.39

64

25.41

29

18.04

63

25.30

28

17.67

62

25.19

27

17.29

61

25.07

26

16.89

60

24.94

25

16.48

59

24.82

24

16.06

58

24.69

23

15.62

57

24.55

22

15.17

56

24.41

21

14.70

55

24.26

20

14.21

54

24.11

19

13.71

53

23.96

18

13.19

52

23.80

17

12.65

51

23.63

16

12.09

50

23.46

15

11.52

49

23.28

14

10.92

48

23.09

13

10.30

47

22.90

12

 9.66

46

22.70

11

 9.00

45

22.50

10

 8.32

44

22.28

 9

 7.61

43

22.06

 8

 6.87

42

21.83

 7

 6.11

41

21.60

 6

 5.33

40

21.36

 5

 4.52

39

21.10

 4

 3.67

38

20.84

 3

 2.80

37

20.57

 2

 1.90

36

20.29

 1 or less

 1.00

INDEXATION ¶20-290 Average weekly ordinary time earnings (AWOTE) The average weekly ordinary time earnings (AWOTE) figure for the relevant quarter is used to index many of the thresholds and limits for tax purposes and tax-related purposes. AWOTE refers to one week’s earnings of employees for the part of total earnings attributable to award, standard or agreed hours of work. It is calculated before taxation and other deductions such as

superannuation. AWOTE excludes overtime, retrospective pay, pay in advance, leave loadings, severance, termination and redundancy payments. AWOTE figures Year

March quarter

June quarter

September quarter

December quarter

2000

774.8

784.2

796.1

800.4

2001

810.6

824.1

838.5

848.7

2002

860.5

866.8

879.4

889.6

2003

900.4

921.0

929.6

938.4

2004

947.8

949.5

962.9

976.4

2005

992.9

1,006.7

1,023.2

1,025.7

2006

1,037.5

1,041.6

1,053.0

1,058.6

2007

1,073.8

1,090.0

1,105.1

1,108.5

2008

1,124.8

1,131.1

1,151.4

1,165.3

2009

1,183.4

1,195.6

1,204.2

1,226.8

2010

1,243.9

1,250.1

1,258.8

1,275.2

2011

1,291.3

1,304.7

1,324.9

1,330.1

2012

1,348.1

1,349.2

n/a*

1,396.0

2013

n/a*

1,420.9

n/a*

1,437.0

2014

n/a*

1,454.10

n/a*

1,477.0

2015

n/a*

1,483.10

n/a*

1,500.50

2016

n/a*

1,516.00

n/a*

1,533.40

2017

n/a*

1,543.20

n/a*

1,569.60

2018

n/a*

1,585.30

n/a*

1,605.50

2019

n/a*

1,634.80

n/a*

1,658.40

* not applicable as figures are now published bi-annually rather than quarterly.

PAYMENT OF SUPERANNUATION BENEFITS ¶20-300 Taxation of superannuation benefits The taxation treatment of a superannuation member benefit paid from a complying superannuation plan (ie benefits other than those paid after the death of the member) is based on: • the age of the benefit recipient • whether the benefit is a lump sum or an income stream • whether the benefit comprises a tax-free component and/or a taxable component, and • whether the taxable component of the benefit includes an element taxed in the fund and/or an element untaxed in the fund.

See ¶4-420 for further details. Preservation age The preservation age of a person depends on the person’s date of birth, as shown below. For a person born …

Preservation age

Before 1 July 1960

55

1 July 1960–30 June 1961

56

1 July 1961–30 June 1962

57

1 July 1962–30 June 1963

58

1 July 1963–30 June 1964

59

After 30 June 1964

60

The tables below outline the taxation treatment of taxed and untaxed amounts paid from a fund for 2020/21. Medicare levy is added to whichever rate of tax applies. Taxation of benefits from a taxed source Age of recipient

Lump sum

Income stream

60 and over

Tax-free

Tax-free

Preservation age to age 59

– No tax payable on amounts Marginal tax rates apply but below the low-cap rate eligible for the 15% tax offset ($215,000 for 2020/21) – 15% on any amount above $210,000 ($215,000 for 2020/21)

Under preservation age

Taxed at 20%

Marginal tax rates apply and no eligibility for tax offset (15% tax offset available for a disability superannuation benefit)

Taxation of benefits from an untaxed source Age

Lump sum

Income stream

60 and over

– Taxed at 15% up to the untaxed plan cap amount ($1.565m for 2020/21) – Excess amounts taxed at the top marginal tax rate (45%)

Taxed at marginal tax rates but eligible for a 10% tax offset

Preservation age to age 59

– Taxed at 15% up to the low Taxed at marginal tax rates and rate cap amount ($215,000 for no eligibility for tax offset 2020/21) – Taxed at 30% between $215,000 and up to $1.565m – Any amounts above $1.565m are taxed at the top marginal rate (45%)

Under preservation age

– Taxed at 30% up to $1.565m Taxed at marginal tax rates and – Any amounts above $1.565m no eligibility for tax offset are taxed at the top marginal rate (45%)

¶20-305 Taxation of superannuation death benefits The taxation of a superannuation death benefit varies depending on whether the payment is in a lump sum or an income stream, whether payment is made to a death benefits dependant of the deceased or a non-dependant (for tax purposes), and whether there is an element taxed in the fund or an element untaxed in the fund. The tables below summarise the tax treatment of death benefit payments to dependants and nondependants. The tax-free component is not included in the tables as it is tax-free in all cases. Medicare levy is added to whichever rate of tax applies. Payments to dependants Age of deceased Any age

Superannuation death benefit Lump sum

Age of recipient

Tax treatment

Any age

Tax-free (not assessable, not exempt income)

Aged 60 and above Income stream

Any age

Taxable component: – element taxed in the fund is tax-free – element untaxed in the fund is taxed at marginal tax rates. Recipient entitled to a 10% tax offset on this amount.

Below age 60

Income stream

Above age 60

Taxable component: – element taxed in the fund is tax-free – element untaxed in the fund is taxed at marginal tax rates. Recipient entitled to a 10% tax offset on this amount.

Below age 60

Income stream

Below age 60

Taxable component: – element taxed in the fund is taxed at marginal tax rates. Recipient entitled to a 15% tax offset on this amount. – element untaxed in the fund is taxed at marginal tax rates.

Payments to non-dependants Age of deceased

Superannuation death benefit

Age of recipient

Tax treatment

Any age

Lump sum

Any age

Taxable component: – element taxed in the fund is taxed at 15% – element untaxed in the fund is taxed at 30%.

Any age

Income stream

Any age

– Cannot be paid as income stream – Income streams that commenced before 1 July 2007 are taxed as if received by a dependant (see above).

SUPERANNUATION CONTRIBUTIONS ¶20-310 Concessional contributions cap

An individual is liable to pay excess contributions charge if the concessional contributions made by or for the individual exceed the concessional contributions cap for the year. The excess contributions are included in the individual’s assessable income and taxed at marginal tax rates.

Concessional contributions cap Income year

Age on 30 June

Cap amount

Age on 30 June

Cap amount

2014/15

49 +

$35,000

< 49

$30,000

2015/16

49 +

$35,000

< 49

$30,000

2016/17

49 +

$35,000

< 49

$30,000

2017/18

Any age

$25,000

NA

NA

2018/19

Any age

$25,000

NA

NA

2019/20

Any age

$25,000

NA

NA

2020/21

Any age

$25,000

NA

NA

A higher (unindexed) concessional contributions cap previously applied to older taxpayers. For 2017/18 and later years, there is no longer a higher cap amount based on age and all individuals are subject to the same general concessional contributions cap regardless of age. Unused concessional cap carry forward From 1 July 2018, an individual who has a total superannuation balance of less than $500,000 on 30 June of the previous financial year is entitled to contribute more than the general concessional contributions cap amount by making additional concessional contributions using any unused amounts from an earlier year. The first year of entitlement to the carry forward unused amounts is the 2019/20 financial year. Unused amounts are available for a maximum of five years, and will expire after this period. The table below illustrates how the unused cap carry forward operates.

Unused concessional cap carry forward * 2017/18

2018/19

2019/20

2020/21

2021/22

General contributions cap

$25,000

$25,000

$25,000

$25,000

$25,000

Total unused available cap accrued

NA

$0

$22,000

$44,000

$69,000

Maximum cap available

$25,000

$25,000

$47,000

$25,000

$94,000

Superannuation balance 30 June prior year

NA

$480,000

$490,000

$505,000

$490,000

Concessional contributions

$0

$3,000

$3,000

$0

$0

Unused concessional cap amount accrued in the relevant financial year

$0

$22,000

$22,000

$25,000

$25,000

* This table assumes there is no indexation increase to the general concessional contributions cap.

¶20-320 Non-concessional contributions cap Non-concessional contributions are generally personal superannuation contributions for which the contributor does not claim a tax deduction and which are not included in the assessable income of the recipient superannuation fund or RSA. A person is liable to pay excess contributions tax if the person’s non-concessional contributions exceed the non-concessional contributions cap for the year.

Non-concessional contributions cap Income year

Cap amount*

2014/15 to 2016/17

$180,000 (6 x $30,000)

2017/18

$100,000 (4 x $25,000)

2018/19

$100,000 (4 x $25,000)

2019/20

$100,000 (4 x $25,000)

2020/21

$100,000 (4 x $25,000)

* The non-concessional contributions cap amount is determined by reference to the concessional contributions cap amount, based on a multiple of the general concessional contribution cap amount for the year. The cap is nil if immediately before the start of the year, an individual's total superannuation balance (¶4-223) equals to or exceeds the general transfer balance cap for the year (¶4-227). Bring forward arrangement A “bring forward” arrangement allows a person who is under 65 years of age in a financial year (Year 1, the trigger year) to have an amount of three times the Year 1 cap amount as his/her non-concessional contributions cap over a three-year period (ie Years 1, 2 and 3) (¶4-240). For example, a person below age 65 in the 2015/16 financial year can have a cap amount of $540,000 for non-concessional contributions made in the 2015/16 to 2017/18 years. The bring forward rule is triggered automatically when contributions in excess of the annual cap are made in a financial year by a person who is under age 65 at any time in the year. The bring forward limit across the three-year period is three times the annual cap amount in the trigger year and is not affected by any indexation increase of the annual cap amount (if any) over that period.

Operation of bring forward cap Financial year

Cap amount

1 (first year)

Three times the non-concessional contributions cap of that year (eg $540,000 in 2015/16, as the non-concessional contributions cap is $180,000)

2 (second year)

The first-year bring forward cap amount minus first-year non-concessional contributions (but not less than $0)

3 (third year)

The second-year bring forward cap amount minus second-year non-concessional contributions (but not less than $0)

Bring forward cap rule from 1 July 2017 — transitional periods From 1 July 2017, the bring forward amount and period depends on a taxpayer’s total superannuation balance on the day before the financial year in which the contributions triggered the bring forward. Transitional period arrangements apply if a taxpayer has triggered a bring forward in either the 2015/16 or 2016/17 financial years. If the taxpayer triggered a bring forward before 1 July 2017 and has not fully utilised the bring forward cap before 1 July 2017, the taxpayer’s bring forward cap is re-assessed on 1

July 2017 to reflect the annual non-concessional contributions cap ($100,000 in 2017/18). During the two transitional periods (2015/16 to 2017/18 — see Row 2; 2016/17 to 2018/19 — see Row 3) in the following table, contributions made before 1 July 2017 will affect the taxpayer’s total nonconcessional contributions capacity over the following two years.

Non-concessional contributions cap

2014/15

2015/16

2016/17

2017/18

2018/19

2019/20

$180,000

$180,000

$180,000

$100,000

$100,000

$100,000

1

$0 to $540,000

2

$0 to $460,000

3

$0 to $380,000

4

$0 to $300,000

CGT cap amount A CGT cap (a lifetime limit for each taxpayer) operates in conjunction with the non-concessional contributions tax regime under which certain contributions are counted towards the CGT cap, rather than the normal non-concessional contributions cap.

CGT cap amount Income year Cap amount 2014/15

$1.355m

2015/16

$1.395m

2016/17

$1.415m

2017/18

$1.445m

2018/19

$1.480m

2019/20

$1.515m

2020/21

$1.565m

¶20-330 Spouse contributions An individual taxpayer may be entitled to a tax offset for superannuation contributions made for the benefit of a spouse. The maximum tax offset in a year of income is $540. From 2017/18, a taxpayer may be entitled to the maximum tax offset if their spouse's income is less than $37,000 for the year. An individual is entitled to the tax offset for an income year of the lesser of 18% of the spouse contributions made or $540 (18% of $3,000) until the spouse’s total income reaches $37,000. When the spouse’s total income is between $37,000 and $40,000, the maximum tax offset ($540) will proportionally decrease and is reduced to nil when the income is $40,000 or more. An individual is however not entitled to the tax offset if their spouse's non-concessional contributions for the year exceed the non-concessional contributions cap for the year or immediately before the start of the financial year, their spouse's total superannuation balance (¶4-223) equals to or exceeds the general transfer balance cap (¶4-227). For other conditions which must be met in order to qualify for the tax offset, see ¶4-275.

¶20-340 Government co-contributions

Employees and self-employed persons are entitled to a government co-contribution for their personal contributions, subject to the eligibility conditions (including an income test) being met (¶4-265). The maximum amount payable is $500. Income year

Lower income threshold

Higher income threshold

2014/15

$34,488

$49,488

2015/16

$35,454

$50,454

2016/17

$36,021

$51,021

2017/18

$36,813

$51,813

2018/19

$37,697

$52,697

2019/20

$38,564

$53,564

2020/21

$39,837

$54,837

Low income superannuation tax offset An individual taxpayer whose adjusted taxable is below $37,000 is entitled to a low income superannuation tax offset based on 15% of the individual's concessional contributions capped at $500 (see ¶4-270).

SUPERANNUATION GUARANTEE CHARGE ¶20-400 Superannuation guarantee charge percentage Employers who provide less than a prescribed level of superannuation support for their employees are liable to pay a superannuation guarantee (SG) charge based on the shortfall plus an interest component and an administration charge (¶4-500). The prescribed level of superannuation support (the “charge percentage”) is set out in the table below. Financial year

Charge percentage

2000/01 to 2001/02

8%

2002/03 to 2012/13

9%

2013/14

9.25%

2014/15 to 2020/21

9.5%

2021/22

10%

2022/23

10.5%

2023/24

11%

2024/25

11.5%

2025/26 and later years

12%

To avoid liability to the SG charge for a quarter, the required amount of employer superannuation support must be provided for each employee (some exceptions apply) by the 28th day after the end of the quarter. SG contributions made by 30 June qualify for a tax deduction in the year in which they are made if all the conditions for deductibility are met.

¶20-410 Maximum contribution base The maximum contribution base acts as a ceiling on an employee’s salary or wages effectively limiting:

(i) the amount of superannuation support that the employer is required to provide for the employee, and (ii) the amount of the SG shortfall (and consequent SG charge) payable in respect of the employee. Year

Amount in a quarterly contribution period

2010/11

$42,220

2011/12

$43,820

2012/13

$45,750

2013/14

$48,040

2014/15

$49,430

2015/16

$50,810

2016/17

$51,620

2017/18

$52,760

2018/19

$54,030

2019/20

$55,270

2020/21

$57,090

SOCIAL SECURITY ¶20-450 Energy supplement The energy supplement is a tax-exempt payment to assist with household expenses including energy costs. The energy supplement is only paid to Family Tax Benefit recipients and Commonwealth Seniors Health Card holders if they have been continuously receiving the energy supplement from 19 September 2016. The rates outlined below are applicable from 1 July 2020. Pensions Family situation

Maximum benefit ($ per fortnight)

Single pensioner

14.10

Partnered pensioners (each)

10.60

Allowance rates This applies to recipients of Jobseeker Payment, Widow Allowance, Partner Allowance, Sickness Allowance and Abstudy. Family situation

Maximum benefit ($ per fortnight)

Single — no children

8.80

Single — with dependent child(ren)

9.50

Single, over 60, after nine continuous months on payment

9.50

Partnered (each)

7.90

Single, NSA principal carer of a dependent child (granted an exemption

12.00

from activity test for foster caring/home schooling/distance education/large family) Single, over age pension age

14.10

Partnered, over age pension age

10.60

Parenting Payments Family situation

Maximum benefit ($ per fortnight)

Single

12.00

Partnered (each)

7.90

Family Tax Benefit Part A Family situation

Maximum benefit    ($ per fortnight)

Aged under 13 years

3.50

Aged 13–15 years

4.48

Aged 16–19 years, secondary student

4.48

Aged 0–19 years, in an approved care organisation

0.98

Base rate for each child

1.40

Family Tax Benefit Part B Family situation

Maximum benefit ($ per fortnight)

Where youngest child is under five years

2.80

Where youngest child is aged 5–18 years

1.96

¶20-460 Maximum benefit entitlement for pensions Family situation

Maximum benefit    ($ per fortnight) * #

Single pensioner

860.60

Partnered pensioners (each)

648.70

Couple separated due to ill health† (each)

860.60

* Pension figures exclude the pension supplement (the maximum pension supplement amount is $69.60 per fortnight for singles and illness-separated couple members; $105 per fortnight combined for couples) and the clean energy supplement (see ¶20-450). # A Pharmaceutical Allowance of $6.20 per fortnight is paid to most pensioners, single or couple (combined), or $3.10 per fortnight if only one of a couple is a pensioner. Rent Assistance may also be available (refer to ¶6-340). † If separation is due to imprisonment, the separated pensioner also receives single rate of pension.

Rates shown are effective from 1 July 2020.

¶20-470 Maximum benefit entitlement for Jobseeker Payment

Family situation/benefit type

Maximum benefit ($ per fortnight)#

No dependent children

565.70

With dependent children

612.00

Single, 60 and over (after nine months on payment)

612.00

Single, principal carer (granted exemption for large family/distance education/foster care)

790.10

Member of a couple

510.80

#

From 20 March 2020 Jobseeker Payment replaced Newstart, Sickness, Widow and Partner Allowances. Rent Assistance may also be available (¶6-340). A COVID-19 supplement of $550 per fortnight may also be available.

Rates shown are effective from 1 July 2020.

¶20-530 Basic income test for pensions Family situation

Income (per fortnight) threshold for full pension*

Income (per fortnight) for part pension#

Single

up to $178

less than $2,066.60

Couple (combined)

up to $316

less than $3,163.20

Illness separated couple (combined)

up to $316

less than $4,093.20

* The income test taper is 50 cents in the dollar (single) and 25 cents in the dollar (couple each). # May be higher if Rent Assistance is paid with pension.

Rates shown are effective from 1 July 2020.

¶20-540 Basic income test for allowances The basic income test (¶6-540) for allowances applies to Jobseeker Payment (replacing Newstart Allowance, Widow Allowance, Partner Allowance and Sickness Allowance from 20 March 2020). Family situation

For full allowance (per fortnight)*

For part allowance (per fortnight)#

Single, no children

up to $106

less than $1,088.50

Single, with dependent children

up to $106

less than $1,166.84

Single, principal carer with dependant children

up to $106

less than $1,675.25

Single, principal carer (exemption for foster caring/home schooling/distance education/large family)

up to $106

less than $2,126.75

Single, aged 60 or over, after nine continuous months on payment

up to $106

less than $1,177.17

Partnered (each)

up to $106

less than $995.50

* Fortnightly income between $106 and $256 reduces fortnightly benefit by 50 cents in the dollar. For income above $256 per

fortnight, fortnightly allowance reduces by 60 cents in the dollar. Partner income which exceeds cut-out point reduces fortnightly allowance by 60 cents in the dollar. # May be higher if eligible for Pharmaceutical Allowance or Rent Assistance.

Thresholds shown are effective from 1 July 2020.

¶20-545 Deeming rates and thresholds The deeming rules apply to assess income from financial investments at a pre-determined deeming rate, regardless of the actual income the investments are earning. Family situation

Single

Pensioner couple

Value of financial investments

Deeming rate (1 July 2019–30 April 2020)

Deeming rate (From 1 May 2020)

Up to $51,800

1%

0.25%

Above $51,800

3%

2.25%

Up to $86,200

1%

0.25%

Above $86,200

3%

2.25%

Deeming rates were reduced due to COVID-19 and took effect from 1 May 2020.

¶20-550 Basic assets test for home owners Family situation

For full pension (per fortnight)*

For part pension (per fortnight)#

Single**

up to $268,000

less than $583,000

Couple (combined)

up to $401,500

less than $876,500

Illness separated couple (combined)

up to $401,500

less than $1,031,500

One partner eligible

up to $401,500

less than $876,500

* Pension is reduced by $3 pf ($78 pa) per $1,000 of assets over full pension thresholds. Allowances are not payable if assets exceed these amounts. Due to COVID-19, the assets test for Jobseeker Payment, Sickness Allowance, Youth Allowance, Austudy and Parenting Payment was temporarily suspended from 25 March 2020. # Limits will increase if eligible for Rent Assistance. ** For Disability Support Pension, basic assets test applies only if over age 21. For under age 21, refer to Centrelink for limits.

Thresholds shown are effective from 1 July 2020.

¶20-560 Basic assets test for non-home owners Family situation

For full pension (per fortnight)*

For part pension (per fortnight)#

Single**

up to $482,500

less than $797,500

Couple (combined)

up to $616,000

less than $1,091,000

Illness separated couple (combined)

up to $616,000

less than $1,246,000

One partner eligible

up to $616,000

less than $1,091,000

* Pension is reduced by $3 pf ($78 pa) per $1,000 of assets over full pension thresholds. Allowances are not payable if assets exceed these amounts. Due to COVID-19, the assets test for Jobseeker Payment, Sickness Allowance, Youth Allowance, Austudy and Parenting Payment was temporarily suspended from 25 March 2020. # Limits will increase if eligible for Rent Assistance. ** For Disability Support Pension, basic assets test applies only if over age 21. For under age 21, refer to Centrelink for limits.

Thresholds shown are effective from 1 July 2020.

¶20-570 Family Tax Benefit Part A rates of payment Base rates of payment 0–19 years of age

$60.90 pf

Maximum rates of payment: Child, 0–12, each

$189.56 pf

Child, 13–15, each

$246.54 pf

Aged 16–19, secondary student

$246.54 pf

0–19 years, in an approved care organisation

$60.90 pf

Thresholds shown are effective from 1 July 2020.

¶20-572 Family Tax Benefit Part A income test limits Income limit for maximum payment One or more children — Family income up to $55,626 pa Income limit beyond which only basic rate paid (pa): NUMBER OF CHILDREN 13–15 YEARS OR SECONDARY STUDENTS 16–19 YEARS Number of children 0–12 years

Nil

One

Two

Three

Nil

—

$79,826

n/a

n/a

One

$72,398

$96,598

n/a

n/a

Two

$89,170

n/a

n/a

n/a

n/a

n/a

n/a

n/a

Three

The income limit is higher if recipient is also eligible for Rent Assistance. Income limit at which the basic rate begins to reduce One child — Up to $98,988 pa. Income limits are higher with additional children. Income limit at which family tax benefit part A may not be paid (pa): NUMBER OF CHILDREN 13–15 YEARS OR SECONDARY STUDENTS 16–19 YEARS Number of children 0–12 years

Nil

One

Two

Three

Nil

—

$104,281

$112,931

$134,357

One

$104,281

$109,573

$129,405

$150,831

Two

$109,573

$124,453

$145,879

$167,304

Three

$119,501

$140,927

$162,352

$183,778

Thresholds shown are effective from 1 July 2020.

¶20-574 Family Tax Benefit Part B rates of payment Maximum rates of payment: Youngest child under 5

$161.14 pf

Youngest child 5–15 (or until the end of calendar year the child turns 18 if a full-time student)

$112.56 pf

Income test A $100,000 threshold applies to the income of the primary income earner. The primary income, in a single or a family situation, will not be eligible for the payment where they earn more than $100,000 a year. If the primary earner earns less than the threshold, then the lower earner can earn up to $5,767 each income year before Family Tax Benefit Part B is reduced. Payments are reduced by 20 cents for each dollar of income earned over $5,767. Thresholds shown are effective from 1 July 2020.

¶20-578 Paid parental leave Eligible parents (the primary carer) will receive the minimum federal wage ($753.90 per week for 2020/21) for a maximum of 18 weeks in the first year after the birth or adoption of a child. To be eligible for the scheme, the person must: • satisfy the work, income and residency tests • be the primary carer of the child • be on leave or not working from the time they become the child’s primary carer until the end of their paid parental leave period. Working fathers and partners may also be eligible for “Dad and partner pay”. The payment consists of two weeks’ leave paid at the minimum federal wage ($753.90 per week for 2020/21). See ¶13-705 for further information.

¶20-580 Aged care The following schedule applies for care recipients who first entered care from 1 July 2014. Rates, charges and thresholds are applicable from 1 July 2020. For those that entered care before 1 July 2014, see agedcare.health.gov.au/aged-care-funding/agedcare-fees-and-charges/archive-residential-care-fees-and-charges. Fee/Charge/Threshold

Rates

Maximum Basic Daily Fee Home care — level 1

$9.63

Home care — level 2

$10.19

Home care — level 3

$10.48

Home care — level 4

$10.75

Residential care

$52.25

Income Free Area (annual amount) Home Care and Residential Care

Annual income up to these amounts is excluded from the income test component of the residential means test and the income test in home care. Income free area (single person)

$27,840.80

Income free area (Couple, Illness separated, single rate)

$27,320.80

Income free area (Couple, Living together, single rate) — relevant to Home Care only

$21,606.00

Income Thresholds (annual amount) Home Care Income Test Individuals with incomes above these amounts are subject to the second cap when calculating the daily income tested care fee in home care and are also subject to the higher annual cap that applies in Home Care. Income threshold (single person)

$53,731.60

Income threshold (Couple, Illness separated, single rate)

$53,211.60

Income threshold (Couple, Living together single rate)

$41,121.60

Asset Thresholds Residential Care Means Test Asset free threshold

$50,500

First asset threshold

$171,535.20

Second asset threshold

$413,605.60

Home Exemption Cap (applies separately to both members of a couple). The net value of the home above this amount is excluded from the value of the resident’s assets.

$171,535.20

Caps on Income Tested Care Fees in Home Care First cap (Daily cap applying on income tested care fees where the consumer’s income does not exceed the income threshold)

$15.43

Annual cap — income not exceeding the Income Threshold (Annual cap applying to income tested care fees where the consumer’s income does not exceed the income threshold)

$5,617.47

Second cap (Daily cap applying on income tested care fees where the consumer’s income exceeds the income threshold)

$30.86

Annual cap — income exceeding the income threshold (Annual cap applying to income tested care fees where the consumer’s income exceeds the income threshold)

$11,234.96

Cap on Means Tested Care Fees in Residential Care Annual cap

$28,087.41

Lifetime Cap on Means Tested Care Fees in Residential Care and Income Tested Care Fees in Home Care

$67,409.85

Maximum Accommodation Supplement Amount

$58.19

Deeming thresholds and rates Single

$53,000

Couple — combined

$88,000

Lower rate (from 1 June 2020)

0.25%

Lower rate (from 1 June 2020)

2.25%

Relevant rates and thresholds for refundable deposits and daily payments Maximum Permissible Interest Rate For all new residents from 1 July 2020 to 30 September 2020

4.10%

Maximum rate of interest that may be charged on outstanding amount of daily payment from 1 July 2020 to 30 September 2020

4.10%

Base interest rate (from 1 June 2020)

2.25%

Minimum permissible asset level — this is the minimum amount of assets a resident must be left with if they pay at least part of their accommodation costs by refundable deposit

$50,500

Maximum refundable accommodation deposit amount that can be charged without prior approval from the Aged Care Pricing Commissioner.

$550,000

ONLINE INVESTING The big picture

¶21-000

Introduction Using the internet for investing

¶21-010

Protecting yourself online

¶21-020

Online investing resources Selecting an online broker

¶21-100

Portfolio management online

¶21-110

Investment chatrooms

¶21-120

Investment blogs

¶21-130

Twitter accounts

¶21-135

Smart phone and tablet applications

¶21-136

Share trading clubs

¶21-140

Stock and market news

¶21-150

Educational resources

¶21-160

Socially responsible investing

¶21-170

Other online investing resources

¶21-180

Fundamental research Finding investment candidates

¶21-200

Company announcements

¶21-220

Stock filters

¶21-230

Fundamental analysis-based tip sheets

¶21-240

New listings

¶21-250

Basic charting facilities

¶21-260

Technical analysis The benefits of technical analysis

¶21-300

Setting up your charting tools

¶21-310

Complementing technical analysis with fundamental data ¶21-320 Technical analysis-based tip sheets

¶21-330

Non-share investments Introduction

¶21-400

Property

¶21-410

Debt markets

¶21-420

Currency

¶21-430

Commodities

¶21-440

Managed funds and superannuation Managed funds and superannuation online

¶21-500

Investing in managed funds

¶21-510

Online superannuation resources

¶21-540

Tracking the business cycle online The business cycle

¶21-600

Monitoring the economy

¶21-610

Monitoring the international economy

¶21-620

Sector rotation

¶21-630

International investing International investing online

¶21-700

International stock exchanges

¶21-710

Investing in US securities

¶21-720

Investing in European securities

¶21-730

Investing in Asian securities

¶21-740

Advanced investing Introduction

¶21-800

Futures

¶21-810

Warrants

¶21-820

Options

¶21-830

Contract for difference

¶21-840

Exchange-traded products Exchange-traded funds

¶21-900

Investing in ETFs

¶21-910

Smart beta

¶21-920

Financial planning online Financial planners and the internet

¶21-950

Client needs today

¶21-960

The evolving financial planning business

¶21-970

Competition with other financial service providers

¶21-980

Robo-advice

¶21-990

Online financial planning resources

¶21-995

¶21-000 Online investing

The big picture This chapter provides an overview of the many investment-related tools and resources available on

the internet. The internet provides private investors with more tools and information than ever before, but it can also be overwhelming .................................... ¶21-010 Protecting yourself online by being aware of phishing and securing your computer .................................... ¶21-020 Some of the investing resources that can be found on the internet include online brokers, portfolio management, investment chatrooms, investment blogs, twitter accounts, smart phone and tablet applications, the latest stock market news and socially responsible investing .................................... ¶21-100 Fundamental analysis is the strategic component of making investment decisions. Investors can find stock recommendations and research, company announcements, new listing information and basic charting facilities on the internet .................................... ¶21-200 Technical analysis is used to fine-tune the timing of buying or selling stocks. Investors can find charting resources and stock recommendations using technical analysis on the internet .................................... ¶21-300 While the majority of online services focus on shares, investors can also find online investment facilities for property investment, the debt markets, currency trading and commodities .................................... ¶21-400 The internet can make choosing managed and superannuation funds easier with information and filtering tools .................................... ¶21-500 Monitoring the state of the economy can help investors make investment decisions. There are many websites that provide information about major Australian and international economic indicators .................................... ¶21-600 The internet also provides an abundance of information for those interested in international investments. Resources include foreign stock exchanges, investment news, stock quote services and investment research websites .................................... ¶21-700 As derivatives, such as futures, warrants, options and contracts for difference (CFDs) grow in popularity, the number of related resources on the internet also increases .................................... ¶21-800 The recent proliferation of products traded on exchange, most notably in the development of the exchange-traded funds market, has dramatically altered the perception that online investing is relevant to shares only .................................... ¶21-900 The internet offers financial planners information and tools, such as financial calculators, to help them manage client relationships .................................... ¶21-950 The internet has fundamentally changed private investor’s relationships with financial planners. Many clients are more informed and expect a more active role in the financial planning process .................................... ¶21-960 Robo-advice is growing in popularity .................................... ¶21-990

INTRODUCTION ¶21-010 Using the internet for investing The internet is an essential part of most private investor’s lives, providing them with more information and tools than a financial institution traditionally had. Some would argue private investors have access to tools that place them on an almost equal footing with professional investors. Some of the benefits the internet provides to private investors include lower transaction costs, low-cost or free research, sophisticated

share analysis tools, company information services, affordable charting and real-time trading facilities. However, the immense glut of investment-related information on the internet also creates information overload. Furthermore, surfing the net to locate useful information is time consuming and regular internet users face the challenge of keeping up-to-date with the latest developments. This chapter provides an overview of some of the more useful websites. The information is organised along various topics, such as fundamental research, technical analysis, non-share investments, managed funds and international investing. Websites that may be of specific use to financial planners are listed in ¶21-950. The benefits of using the internet for financial planning businesses are discussed in ¶21-970. Robo-advice is included in ¶21-990. Using the internet for investing Website

Services

Money Smart www.moneysmart.gov.au

Government website that provides free and impartial financial guidance and tools.

Investopedia www.investopedia.com/

Provider of online investing courses.

¶21-020 Protecting yourself online The internet is a popular way to invest, but some people exploit investors by tricking them into revealing personal information online, such as usernames, passwords and personal financial information. This is known as “phishing”. The term relates to the baits used to “catch” financial information and passwords. Phishing emails often look authentic and purport to be from a trustworthy source. While they may use the names of real people, have the right logos and fine print, they give themselves away by asking a person to provide their personal details via a reply email or website. Online investors should also secure their computer by running and maintaining an anti-virus product, not running or installing programs of unknown origin and using a personal firewall.

ONLINE INVESTING RESOURCES ¶21-100 Selecting an online broker The Australian Stock Exchange (ASX) reports that 65% of share investors have used an online broker to trade shares. Many of these investors may turn to their financial planners for help with online trading, so it is important financial planners ensure they are able to advise clients of the relative advantages and disadvantages of online trading, and the best online broker to suit their needs. Issues to consider The issues to consider when choosing an online broker include the following. • Brokerage cost and other fees: When choosing an online broker, clients should not be wholly influenced by the cheapest brokerage rate, but should also consider the services offered, such as research, execution speed and reliability. Active investors may also seek out frequent trader discounts. Some brokers may charge membership fees for access to the full range of features, or charge for services such as amending orders, account maintenance and lost Shareholder Registration Number requests. It is advisable to check the broker’s fee structure, as the costs for these services can add up if used often. • Services offered: The quality of service can vary widely between different brokers, and new features are constantly being added. Some of the services you can expect include full tax reporting, summarising the trader’s tax position at the end of the tax year order splitting, which allows an

investor to buy or sell the same share at a number of price points in one transaction, conditional orders, access to Contracts for Difference (CFD) trading and position indicators, which show the position of an investor’s trade in relation to the market. Online investors also value information to help them identify investment opportunities. Investors should consider the service level they need. If they only trade a few times per year, they may not wish to pay for features and services they do not use. • International trading: Some online brokers provide investors with affordable international trading services. • Trading platform: If clients require portability when trading, they should consider a trading platform they can access from any web browser or mobile device, such as their phone or tablet, rather than having to install files on their computer and only accessing the trading platform from that computer. • Other considerations: Investors should also consider whether they need conditional order facilities, access to margin lending, price alerts, course of trade services and option writing facilities. Finding an online broker Website

Services

ASX www.asx.com.au/asx/research/ findABroker.do

A complete list of brokers is available from the ASX website

Canstar www.canstar.com.au/online-trading

Compare online broking website using Canstar’s comparison tool.

Other websites comparing stock broking services: InfoChoice www.infochoice.com.au/?s=online+brokers finder www.finder.com.au/best-online-share-trading-platforms Online Brokers Australia www.onlinebrokersaustralia.com.au/comparingchoosing-an-online-broker/

Comparison of online broking websites.

¶21-110 Portfolio management online Using an online portfolio management service eliminates much of the complexity, time and work associated with keeping track of investment portfolios, especially for taxation purposes. Portfolio management websites Website

Services

Computershare www-au.computershare.com/investor

Provides investors with a single online point of access to their shareholding information.

Link Market Services investorcentre.linkmarketservices.com.au

A registry website that gives investors access to manage their holding in any company which it provides registry services to. Investors can view holding and payment history, as well as update TFN details, payment instructions and communication preferences.

Sharesight www.sharesight.com.au

A subscription-based portfolio management service for shares, which automatically updates transaction data in real-time and

provides comprehensive reporting. Netwealth www.netwealth.com.au

Netwealth’s Investment Wrap provides a complete online investing, transactional and reporting facility for cash, managed funds and shares, allowing you to easily keep track of your investments, dividends, distributions and income.

¶21-120 Investment chatrooms Investment chatrooms can be a good way to share ideas and stock information. Access to chatrooms is usually free. However, keep in mind that members’ experience level will vary. Some are experienced professional home traders willing to share ideas and stock tips, whereas others are novice investors asking for help and explanations. Investment chatroom websites Website

Services

IncredibleCharts www.incrediblecharts.com/forums

Discussion topics include market analysis, indicators, chart patterns, trading psychology, trading systems and reviews.

HotCopper www.hotcopper.com.au

One of Australia’s most popular discussion forums for topics such as ASX stocks, IPOs, the economy, commodities and humour. HotCopper also features some unique features, such as Post Rating, which allows members to rate the quality of posts.

Online Traders Forum onlinetradersforum.com

Popular and simple stock forum.

ShareScene.com www.sharescene.com

Allows investors to discuss current investment issues, events, financial analysis and charting. Includes share tipping competitions, TV reports, special guest discussions and ShareScene Radio, which provides interviews with company CEOs and a rewards program.

Aussie Stock Forums www.aussiestockforums.com

Forum for discussing Australian shares. Includes information about trading seminars, an event calendar and live chats. You can also follow Aussie Stock Forums on Twitter.

Topstocks.com.au www.topstocks.com.au

An ASX stock market discussion forum. Includes trading tools, a unique member ranked stock tipping system, your own trading diary and consensus reporting.

¶21-130 Investment blogs Investment blogs are sources of inspiration for fresh investing ideas, with some rivalling newspapers and other professional sources for insight and information. Website

Commentary

Shareswatch Australia www.shareswatch.com.au

Views about the Australian stock market, shares, the economy, investing, politics and world events.

MacroBusiness www.macrobusiness.com.au

Attempts to narrow the gap between the Australian business media and reality. MacroBusiness uses reason, history and ideas to bring readers a bigger picture of the choices we face for our economy, businesses and investments.

BlackRock Blog www.blackrockblog.com

Blog is written by financial professionals and suits investors who want more in-depth information about strategies and products.

Roger Montgomery rogermontgomery.com

Roger Montgomery founded Montgomery Investment Management following a successful career as a fund manager, public company chairman and investment author. He is particularly passionate about putting successful stock market investing within the reach of everyone.

¶21-135 Twitter accounts In addition to blogs, there are some interesting investing Twitter accounts you can follow. Twitter account

Commentary

Victor Ricciardi twitter.com/#!/victorricciardi

Behavioural finance and risk expert, Finance Professor at Goucher College, SSRN Editor, radio guest. Victor Ricciardi posts behavioural finance news on Twitter.

Jason Zweig twitter.com/#!/jasonzweigwsj

An investing columnist for The Wall Street Journal.

Leith van Onselen twitter.com/#!/leithvo

Leith van Onselen is a co-founder of MacroBusiness.com.au where he writes as the Unconventional Economist.

CommSec twitter.com/CommSec

Keep up to date with the latest news and information on investment markets.

Confident Investor twitter.com/confidentinvest

Teaching people the skills they need to confidently invest in the stock market. Author of The Confident Investor.

Loretta Iskra twitter.com/LorettaIskra

Loretta Iskra is a lecturer teaching financial planning and researching retirement income policy.

Miss Money Box twitter.com/missmoneybox

Focused on helping women gain finance knowledge.

Scott Pape twitter.com/scottpape

Scott Pape is an author and radio commentator.

¶21-136 Smart phone and tablet applications

Increasingly, investors are using their smart phones to help them keep track of the market. Some of the more popular phone applications (apps) are listed below. App name

Services

Stock TickerPicker Available for iPhone

View a watch list of real-time stock quotes and daily stock/charting data for technical analysis.

FRED Economic Data Available for iPhone and iPad

Federal Reserve Economic Data is a repository with tens of thousands of time series for various economic datapoints, allowing you to chart 765,000 economic data series from around the world.

StockLight — ASX stocks and value investing ratios Available for iPhone, iPad and Android

A share market investing app by Intelligent Investor, StockLight helps you track your portfolio and research new investing ideas.

MarketDash Available for iPad

A free Yahoo! Finance app, MarketDash provides access to your investment portfolios and watch lists with real-time tracking throughout the trading day and breaking coverage of top market stories.

ASX iPhone app Available for iPhone

This free app lets you monitor your 20 favourite companies (prices are 20 minutes delayed) plus the S&P/ASX 200 and the All Ords indices and receive real-time company announcement alerts.

Trade-Ideas Intraday Stock Screener Available for iPhone, iPod touch and iPad

A stock screener allowing users to use preconfigured screens or customise a screen to fit their trading style utilising advanced filters.

¶21-140 Share trading clubs A common thread running through commercial share trading clubs is high upfront fees. For their money investors can expect: • support and member help lines • a software trading package, and • a data service. Investors may also receive mentoring, training, stock recommendations, market updates and investment reports. Bear in mind most of these services are available free or at cheaper rates elsewhere and the benefit of joining a club largely lies in having someone package the services on one website. Share trading club websites Website

Services

TraderHQ.com www.traderhq.com

Focuses on offering an educational and coaching service.

Australian Investment Education

Aims to provide knowledge and resources for retail

australianinvestmenteducation.com.au

investors and traders about the markets through support, coaching, mentoring and advisory services.

Optionetics www.optionetics.com.au

Provides portfolio management techniques, market analysis and online market tools. Helps traders navigate the market with high-profit, low-risk and low-stress trading strategies while avoiding overly theoretical or technically complicated material.

Traders Circle www.traderscircle.com.au

Provides ongoing education, support, tools and analysis for traders.

Interactive Brokers Asset Management — Covestor covestor.com

Provides over 150 model managers, both professionals and individual investors, whose portfolios can be viewed, studied and mirrored with a Covestor account. Users can find managers that fit their strategy, sector and risk goals to follow.

eToro www.etoro.com

A global marketplace for people to trade currencies, commodities, indices and CFD stocks online using an open network that anyone can join and where they can share, learn, copy, interact and compete with one another.

Trading Game tradinggame.com.au

Chris Tate and Louise Bedford help people with limited time and knowledge trade through simple techniques traders can implement straight away.

¶21-150 Stock and market news Website

Services

Australian Financial Review Personal Finance www.afr.com/personal-finance

A source for the latest personal finance news from Australia and the world online.

The Daily Reckoning www.dailyreckoning.com.au

An independent perspective on the Australian and global share markets. Tries to tell investors what news is worth paying attention to and what it might mean for their money.

FN Arena www.fnarena.com

A financial news service. A popular feature is Australian Broker Call, which provides the latest opinions, recommendations, targets and forecasts by the 10 leading Australian stock brokers and equity investment advisers.

Bloomberg www.bloomberg.com

Provides a variety of investment news, including financial news, stock and bond market information, commodities news and market statistics.

Yahoo! Finance au.finance.yahoo.com

Provides comprehensive information about investing and finance.

The Bull www.thebull.com.au

Run and owned by finance journalists. Includes regular stock tips.

CommSec youtube.com/CommSecTV

Keep up to date with the latest news and information from Australian investment markets delivered by video.

¶21-160 Educational resources There is an abundance of information about investing on the internet. Investing in an education about the markets is a prerequisite for all self-directed investors. Learning about fundamental analysis Website

Services

Financial Services Institute of Australasia www.finsia.com/

Provides practical, contemporary and innovative education that encompasses the major investment and securities markets.

The Barefoot Investor www.barefootinvestor.com

Contains entertaining investment articles and offers a free newsletter service.

Australian Stock Exchange www.asx.com.au/resources/shares-courses.htm

This course uses modules to provide the basic information you need to understand the share market and start trading. Suitable for first-time investors or as a refresher for active investors.

Learning about technical analysis Website

Services

Australian Technical Analysts Association www.ataa.com.au

Investors can apply for a Diploma of Technical Analysis here. The ATAA also publishes a bimonthly journal.

Building Wealth Through Shares www.bwts.com.au

Provides articles dealing with charting, psychology and trend trading.

Daryl Guppy www.guppytraders.com

Private Australian trader Daryl Guppy publishes technical analysis tutorials.

Wealth Within www.wealthwithin.com.au

Specialises in share market education and independent investment advice.

Sharetradingeducation.com www.sharetradingeducation.com

Using the expertise of Jim Berg, the website caters to beginners by describing fast track strategies and simple techniques for making money in the market, and advanced traders who want more strategies to boost trading results.

¶21-170 Socially responsible investing Socially responsible investing takes the greater social good into account when making investment decisions, including environmental considerations, consumer protection and human rights. Website

Services

Responsible Investment Association Australasia www.responsibleinvestment.org

Peak industry body for professionals working in responsible investment in Australia and New Zealand.

Corporate Analysis. Enhanced Responsibility www.caer.com.au

Corporate Analysis. Enhanced Responsibility is an independent, not-for-profit research organisation helping investors apply environmental, social and governance criteria to their investments.

¶21-180 Other online investing resources Website

Services

Unclaimed money www.moneysmart.gov.au

Perform a free search for money classified as unclaimed from financial institutions and companies using the Australian Securities and Investments Commission Unclaimed Money online search.

Delisted Companies www.delisted.com.au

Shareholders can find information on companies in administration, receivership or liquidation.

FUNDAMENTAL RESEARCH ¶21-200 Finding investment candidates When selecting stocks, the initial task is to find good investment candidates from a strategic viewpoint. Before investing in a company, an investor must feel confident and have an understanding of the company’s prospects and risk profile. Fundamental analysis is the strategic component of the investment decision-making process, whereas technical analysis (¶21-300) aims to bring the probability of a correct timing decision in the investor’s favour. Stock research involves assessing the company’s growth prospects and determining how expensive the company is relative to that growth. This can be achieved using a “top down” approach, which locates the best performing sectors and then invests in companies from those sectors, or a “bottom up” approach, which involves selecting individual stocks expected to perform better than their peers. This is usually done by applying various ratios, such as the price to earnings ratio and debt to equity ratio. Some investors may also be interested in using broker share recommendations. However, when analysing short-term trading opportunities, investors should look for changes in recommendations, not just the buy/sell/hold recommendation itself. Investors can also examine the level of consensus to get an idea of how most brokers view the stock. At times, brokers will differ in their view of a particular stock, as they analyse stocks differently or may have better information than others. These diverse views and opinions provide a balanced view of the stock.

¶21-220 Company announcements The internet has made it easier for investors to keep up with company developments. Websites providing company announcements Website

Services

Open Briefing www.openbriefing.com

Major company announcements and “Open Briefings”, which follow such announcements.

Australian Stock Exchange www.asx.com.au/asx/statistics/ announcements.do

Announcements are available dating back to 1998.

BRR Media www.boardroom.media

A source of webcasts and video broadcasts from ASX listed companies covering everything from market announcements to AGMs.

Hot Copper hotcopper.com.au/announcements/asx

Each company announcements links to a forum discussion about the information.

¶21-230 Stock filters Stock filters allow investors to search the stock market for stocks that fit into certain predetermined criteria, such as earnings growth, price to earnings or yield. The stock filter then presents the investor with a list of stocks based on the investor’s requirements. Online stock filters Website

Services

Financial Times — London markets.ft.com/screener/ customScreen.asp

Provided by The London Financial Times, this excellent free stock filter allows investors to perform various searches on stocks from around the world, including Australia.

Morningstar www.morningstar.com.au

The Morningstar website provides paid access to Aspect Equity Review, which includes a value model that allows users to determine the intrinsic value of their preferred stocks and compare the intrinsic value to the current share price. The value model can also be used to see what numbers the market is implicitly using to value a stock and assess whether these assumptions are realistic.

Share Filter www.sharefilter.com

Provides stock screens on ASX, HKSE, NASDAQ and the SGX stock markets.

Incredible Charts www.incrediblecharts.com.au

Provides stock screening capabilities for the ASX plus US and UK stock exchanges. Stocks can be screened using signals generated by Bollinger bands, directional movement, gaps, moving average crossovers, MACD, price, RSI, stochastic, volatility and volume. Allows subscribers to share their scans.

Stocks In Value www.stocksinvalue.com.au/features/ stock-filter

There is a free trial for this filter, which aims to find stocks whose value is calculated as higher than their current market price.

¶21-240 Fundamental analysis-based tip sheets Tip sheets are often used by investors who prefer to rely on professional analysts, rather than studying company and earnings reports themselves. Websites providing stock recommendations Website

Services

Morningstar www.morningstar.com.au/Stocks

Provides investment newsletters, including Huntleys’ Your Money Weekly, which incorporate opinion on researched stocks and model portfolios.

The Intelligent Investor www.intelligentinvestor.com.au

An independent publication that follows the principles of value investing.

Fat Prophets www.fatprophets.com.au

Stock recommendations based on technical and fundamental analysis.

Under The Radar Report www.undertheradarreport.com.au

This report reviews small-cap companies and provides buy and sell recommendations.

Wise-Owl www.wise-owl.com

Combines fundamental, quantitative and technical analysis to find investment opportunities.

Australian Stock Report www.australianstockreport.com.au

Provides trading suggestions based on technical and fundamental analysis.

Eureka Report www.eurekareport.com.au

Research on Australian stocks, including stock recommendations, strategies and model portfolios.

Marcus Today www.marcustoday.com.au

Includes a daily Australian stock market newsletter, a step-by-step guide to a safe investment portfolio and articles about investing.

¶21-250 New listings New listings provide investors with tempting opportunities due to their volatility, but this also implies higher risk, so it is important to become educated before investing. Sites to consider for new listing information Website

Services

InvestSmart www.investsmart.com.au/floats/upcoming

Comprehensive information about new listings.

Australian Stock Exchange www.asx.com.au/prices/upcoming.htm

Information about upcoming and recent floats.

¶21-260 Basic charting facilities Good charting facilities can be important for investors, even if they are not interested in becoming fully fledged technical analysts (¶21-300). However, maintaining your own charting facility requires the purchase of a software package and regular downloading of data. Investors who do not want to commit to this expense, or do not have the time, have the following options. Free online charting facilities Website

Services

Incredible Charts www.incrediblecharts.com

Free interactive charting facilities and delayed data. A useful feature is the stock screening facility.

Yahoo! Finance au.finance.yahoo.com

Provides access to basic customisable stock charts.

Australian Stock Exchange www.asx.com.au/prices/charting

Tracks the price, volume and moving average of shares.

Space Jock www.spacejock.com

Free stock, futures and currency charting software with price and volume charts, user-defined indicators and portfolio tracking facilities. Includes live intraday charting.

TECHNICAL ANALYSIS ¶21-300 The benefits of technical analysis

Some investors are willing to purchase a stock provided it passes the fundamental analysis evaluation. Others, especially those with a shorter time horizon, prefer to fine-tune their stock entry with the help of technical analysis. Technical analysis can help improve long-term profitability by: • identifying profitable investment opportunities • locating a preferred stock entry point, and • protecting capital through money management techniques. This section provides an overview of online resources available to investors interested in incorporating technical analysis into the investment decision-making process.

¶21-310 Setting up your charting tools Software Charting software displays share price data in charts to help investors see trends and areas of support and resistance. Deciding which software package to purchase depends on individual needs. There are three main software package categories: • Black box. Usually very expensive (around $10,000 with ongoing fees) and sold by high pressure salespeople. Users are unaware of how buy and sell signals are generated. Black box systems usually promise high returns over short periods and are often criticised, as markets continually change and no system can consistently work across all markets or for all personalities. • Grey box. Usually a combination between a black box and a toolbox, where the user has some control over the input criteria from which buy and sell signals are generated. • Toolbox. The user has full control over any input criteria. Toolboxes are used for drawing graphs and overlaying them with technical indicators. They may also have some system design and backtesting capabilities. Some of the issues investors should consider before purchasing a software package include: • The investor’s experience. Different packages cater for a wide range of experience. Beginners should ensure the technical support and tutorial functions suit their needs. • The investor’s trading approach. Some packages specialise in certain areas and may only benefit certain users. Other issues to consider include the type and number of indicators required and whether you need a portfolio manager or market scanning facility. Investors should examine which software package caters to their own particular trading style. • Design and style. Software packages vary in quality, depth and ease of use. Find one that accommodates your tastes and needs. • Price. Prices vary dramatically between packages. The more expensive packages usually incorporate charting and trading software. Free shareware programs are also available for download from the internet. Examples of popular technical analysis software packages Software

Description

MetaStock www.metastock.com/products

The most popular charting and trading software program.

BullCharts

A charting and technical analysis system providing

www.bullcharts.com.au

access to a range of indicators and scans. The software is designed to be intuitive and easy to use.

AmiBroker www.amibroker.com

Includes an excellent backtester that can reproduce most trading strategies with real-life accuracy. Can be adjusted to fit your personal trading needs.

OmniTrader www.corporatedoctor.com.au

Generates entry and exit signals based on major technical indicators.

TradeStation www.tradestation.com/

Designed for professional traders.

Insight Trader www.insighttrader.com.au

Specifically designed for the Australian stock market.

Ezy Chart www.ezychart.com

Entry level software.

eSignal www.esignal.com

eSignal offers real-time, delayed and end-of-day data, coupled with advanced trading analysis tools, charting and indicators. Traders can integrate the software with their choice of direct access brokerages for instant executions.

Incredible Charts www.incrediblecharts.com.au

A low-cost charting platform that includes a slightly delayed data service. The charting package includes over 50 indicators and stock screening capabilities.

Data services Investors may also require price data if it is not already bundled with their technical analysis software package. Data services typically include historical data for the past eight to 10 years. Getting regular end-of-day data is easy and fairly inexpensive. Real-time data services are also available. Data services websites Software

Description

WebLink www.weblink.com.au

Inexpensive intraday and end-of-day data services.

dataHQ www.datahq.co.uk

Data specifically designed for use with Metastock software.

Norgate Investor Services www.premiumdata.net

Provides end-of-day securities data to retail-level clients.

Almax www.almax.com.au

Data is compatible with many popular charting packages.

¶21-320 Complementing technical analysis with fundamental data Some data service providers supply fundamental data, creating new opportunities for investors interested in complementing technical and fundamental analysis. IntegratedInvestor www.hubb.com/Software.aspx

This software combines the power of different market analysis techniques to improve share selection and investment portfolio performance. Features include trading lists, a technical and fundamental dashboard, broker recommendations plus news and articles.

¶21-330 Technical analysis-based tip sheets Website

Description

Stockradar www.stockradar.com.au

Provides insight into market sentiment using technical analysis, with a focus on ASX 200 stocks with compelling trending qualities.

Wise-Owl www.wise-owl.com

The Wise-Owl Equities Report includes technical analysis-based information.

Australian Stock Report www.australianstockreport.com.au

Provides daily trading suggestions based on technical and fundamental analysis of the Australian stock market. Also provides informative material about the application of fundamental and technical analysis tools.

NON-SHARE INVESTMENTS ¶21-400 Introduction While online investment resources tend to deal predominately with shares, other asset classes are also covered. This section discusses online investing in relation to property, interest-bearing securities, currency and commodities.

¶21-410 Property Through property, investors can obtain consistent and less volatile returns in the form of rental income and capital gains. Investors can access the property market through listed and unlisted property trusts or direct investment. International property exposure is best gained through managed funds. Property investments are also discussed at ¶9-310 and ¶9-312. Property investment-related websites Service

Description

PropertyInve$ting.com www.propertyinvesting.com

Provides information about property investing and includes a forum for discussing property investment ideas.

Australian Property Monitors www.apmpricefinder.com.au

Publishes home and commercial property price guides.

Property Council of Australia www.propertycouncil.com.au

Issues statistics, news and various publications on the property markets.

Domain www.domain.com.au

Publishes buy, sell and rent property listings. Also features an “invest” section that details the best and worst performing suburbs and provides suburb profiles.

iProperty iproperty.com.au

Access property news and listings of residential and commercial property for sale.

Investing in Property

Helps investors develop clear, achievable property

www.investinginproperty.com.au

investment objectives and access a network of developers, brokers, tax experts, solicitors and valuers.

realcommercial.com.au www.realcommercial.com.au

A commercial property listing portal.

DomaCom www.domacom.com.au

A property investment platform that enables investors to make “fractional” property investments, applying a concept similar to investing in shares.

Property Update www.propertyupdate.com.au

Tips and strategies from Australia’s leading real estate, finance and property tax experts.

homesales.com.au www.homesales.com.au

Provides a search engine to help property investors find investment properties based on their investment strategy. Also includes a regular newsletter.

Comelli Commercial www.comelli.net.au

A regional commercial property listing portal.

¶21-420 Debt markets The debt markets (¶9-110–¶9-200) involve the investor lending money with the expectation of full repayments and the payment of interest. Debt markets include at-call money, bank bills, term deposits, mortgages, annuities, debentures and bonds. The internet does offer some research material, tools and direct access to these instruments. Debt market websites Website

Description

Cashwerkz cashwerkz.com.au

An investment management platform that simplifies the process of selecting, placing and switching term deposit products from participating providers.

Australian Money Market www.moneymarket.com.au

A platform that enables advisers and accountants to manage term deposit holdings through a single portal, and streamlines the administration of investing.

Macquarie Bank Macquarie’s fixed interest section provides www.macquarie.com/mgl/com/mim-emea/en/fixed- information and pricing on fixed interest securities. income-and-currency FIIG www.fiig.com.au

Provides access to fixed income markets, research and education.

Australian Stock Exchange www.asx.com.au/products/ interest-rate-derivatives.htm

ASX interest rate futures and options are leveraged instruments allowing investors and traders to gain and manage their exposure to short and long-term Australian and New Zealand interest rates.

¶21-430 Currency

Currency trading involves the simultaneous buying of one currency and selling of another, and is the largest and most liquid market in the world. This makes it an ideal market for active traders. Foreign exchange websites Website

Description

OFX www.ofx.com.au

An Australian company offering good rates and an easy way to transfer and receive funds internationally.

CMC Markets www.cmcmarkets.com.au

Provides foreign exchange CFDs trading in all major global currencies for the retail market.

Computrade www.computrade.com.au

Provides currency trading software and online education for FX Trading.

FXCM www.fxcm.com

FXCM is one of the largest non-bank forex capital markets in the world that specialises solely in spot foreign exchange. Offers a free practice account.

OANDA www.oanda.com

Provides currency exchange information and a currency trading platform.

Forexct.com www.forexct.com.au

Provides a web-based trading system with an easy dealing process and personalised support, including free trading tutorials and research reports.

Easy Forex Australia www.easyforex.com.au

An Australian company, allowing you to keep your money on-shore. Can also make deposits using your credit card.

Go Markets www.gomarkets.com

Offers beginner accounts and advanced traders. Based in Australia.

City Index www.cityindex.com.au/international/

Provides innovative trading platforms through its own propriety technology.

¶21-440 Commodities Investors may choose to diversify their portfolio to include commodities, such as gold. Keeping track of commodity prices can also be important for stock selection and to determine the general market’s direction. Commodity websites Website

Description

Minerals Council of Australia www.minerals.org.au

Represents Australia’s exploration, mining and minerals processing industry.

National Farmers’ Federation www.nff.org.au

Provides fully sourced and attributed data on Australia’s leading agricultural commodities, including beef, cotton, dairy, dried fruits, goats, grains, rice, sheep meat, sugar and wool.

www.moneymorning.com.au/ commodities

Money Morning Australia is an independent publication.

Australian Bureau of Agricultural and Resource Economics and Sciences

An Australian government economic research agency providing independent research, analysis

www.agriculture.gov.au/abares

and advice about current and future policy challenges affecting Australia’s primary industries.

Reserve Bank of Australia www.rba.gov.au/statistics/frequency/ commodity-prices

The RBA publishes a monthly index of commodity prices.

Kitco www.kitco.com

Prices and charts for gold, silver, platinum, palladium and other commodities.

CNN Money money.cnn.com/data/commodities

Access to 20-minute delayed US futures prices for energy, metals and livestock.

National Australia Bank business.nab.com.au/tag/commodities

The National Australia Bank publishes research and insights into the commodity sector.

Easy Forex www.easymarkets.com.au/ commodities-trading

Easy Forex allows trading in various commodities against the US Dollar, including WTI Crude Oil, Brent Crude, Gas Oil and Heating Oil.

GoldMoney www.goldmoney.com

Allows investors to buy and sell gold and silver over the internet.

MANAGED FUNDS AND SUPERANNUATION ¶21-500 Managed funds and superannuation online With so many managed investment products on offer, the internet can make choosing the right managed fund for your client much easier. When deciding which managed fund is best, not only must you consider your client’s investment style and objectives, but you must also take into account other issues, such as tax structures and asset classes. The internet has made these choices easier by allowing advisers to search for managed funds based on various criteria, such as pricing, fees, performance, asset allocation and fund size (¶21-510). The internet is also increasingly catering for superannuation investments, with product offerings, investment tools and educational material. Guidance to the wealth of information available can be found at ¶21-540.

¶21-510 Investing in managed funds There are numerous websites that provide research, search tools and the ability to download prospectuses for online investors. Tools for researching managed funds online Website

Description

Investsmart www.investsmart.com.au/ managed-funds

Managed fund analysis, news and ratings. Also provides an excellent fund search tool.

MoneySmart www.moneysmart.gov.au

MoneySmart is run by the Australian Securities and Investments Commission (ASIC) and provides a managed funds calculator that shows the effect of fees, regular contributions, changing funds and different investment options.

Index Funds www.indexfunds.com

This US-based website offers access to quality information about index funds.

2020 DIRECTINVEST www.2020directinvest.com.au

Provides access to Australian managed funds plus research, investor tools, investment seminars and email alerts.

Morningstar www.morningstar.com.au/Tools/ FundScreener

Provides a fund screener to help users find funds using a variety of criteria.

Westpac Online Investing onlineinvesting.westpac.com.au

Provides a managed funds supermarket where investors can access a wide range of managed funds across various asset classes, including fixed interest, property, Australian shares and international shares. A “fund finder” tool help investors select funds, along with Morningstar research and ratings.

¶21-540 Online superannuation resources Increasingly, the internet is providing investors with access to superannuation investments, tools and educational material. Some of the more popular websites include the following. Superannuation websites Website

Services

Australian Securities and Investments Commission: MoneySmart www.moneysmart.gov.au/ superannuation-and-retirement

Provides information about superannuation investments. Also provides useful superannuation calculators.

e-superfund www.esuperfund.com.au

Provides online self-managed superannuation.

Super Easy www.supereasy.com.au

Allows investors to set up their own self-managed superannuation fund online.

ATO’s Searching for lost super www.ato.gov.au/forms/searching-for-lost-super/

ATO online search for lost superannuation accounts.

Find My Super www.findmysuper.com.au

Assists investors in finding their lost superannuation accounts.

Australian Financial Complaints Authority www.afca.org.au/

Deals with complaints about superannuation, annuity policies and retirement savings accounts, received on or after 1 November 2018.

Superannuation Complaints Tribunal www.sct.gov.au

Deals with complaints about superannuation, annuity policies and retirement savings accounts, received on or before 31 October 2018.

Superannuation ratings agencies: Selecting Super — www.selectingsuper.com.au SuperRatings — www.superratings.com.au Chant West — www.chantwest.com.au

Comparison of superannuation funds.

Grow Super www.growsuper.com

Provides a superannuation savings app.

TRACKING THE BUSINESS CYCLE ONLINE

¶21-600 The business cycle Understanding the business cycle allows investors to anticipate market responses to economic developments. This can help investors decide when to invest and determine which particular sector offers the most promising returns. Business activities fall into four distinct phases and are strongly correlated with the rate of economic growth as measured by Gross Domestic Product. These include peak to contraction, recession, trough to recovery and expansion. During the different stages of the business cycle, the perceived value of various asset classes, such as cash, bonds, equities and commodities, changes. These changes create trading opportunities.

¶21-610 Monitoring the economy Many investors monitor the economy to understand the fundamental reason for major market movements. Investors can monitor the economy by studying economic indicators, such as unemployment figures, retail sales, national income statistics, and consumer and business surveys. By following economic activity investors can: • use economic indicators for forecasting, allowing them to make asset allocation and trading decisions based on anticipated changes in government economic policy • use economic indicators to confirm signals generated through technical analysis at important market turning points (¶21-300) • use economic indicators to anticipate potential sector rotation changes (¶21-630) • gain an advantage by being aware of how and when economic news will impact markets. However, there are limitations to economic indicators, including timeliness, reliability, accuracy and volatility. Useful websites for tracking economic indicators Website

Services

Westpac Bank www.westpac.com.au/aboutwestpac/media/reports

Publishes commentary on various economic indicators and also publishes the Leading Index of Economic Activity in conjunction with the Melbourne Institute of Applied Economic and Social Research.

The Australian Bureau of Statistics www.abs.gov.au

Publishes a wide range of economic information, including national accounts, Consumer Price Index, labour force statistics, retail sales data and building approvals.

Reserve Bank of Australia www.rba.gov.au

Publishes quarterly bulletins assessing current economic conditions and prospects for inflation and growth.

ANZ www.anz.com/corporate/research

Publishes a quarterly economic outlook detailing the latest views on the international and Australian economies.

Australian Industry Group www.aigroup.com.au

Publishes a monthly AIG Performance of Services Index, which condenses data into an overall boom or bust index based on sales, new orders, employment, inventories and deliveries. The index is significant as the services sector accounts for a

majority of Australian GDP.

¶21-620 Monitoring the international economy International developments have long had an impact on Australia’s economy and will continue to do so in the future. For example, emerging market economies provide Australia with strong growth opportunities through resource and agricultural commodities, while fiscal and banking problems in many advanced industrialised countries are proving a drain on our economy, affecting interest rates and exchange rates. As a result, investors must monitor overseas influences to adequately determine how the Australian economy will fare. Useful websites for tracking international economic indicators Website

Services

The Conference Board www.conference-board.org

Conducts research, makes forecasts and assesses economic trends. Also provides information about leading economic indicators and business cycles for several countries.

Economagic www.economagic.com

Provides a wealth of economic data, from how interest rates have changed over the past few decades to the amount of credit market debt outstanding.

International Monetary Fund www.imf.org/external/data.htm

The IMF publishes data on lending, exchange rates and other economic and financial indicators.

The Federal Reserve (US) www.federalreserve.gov

Provides access to Federal Reserve statements on the stance of monetary policy, statistics, surveys and bulletin articles analysing economic developments.

Institute for Supply Management www.instituteforsupplymanagement.org

Provides historical data for manufacturing and nonmanufacturing indices and publishes the Purchasing Managers Index (PMI). A PMI reading above 50% indicates manufacturing is expanding, while a reading below 50% shows that it is declining.

Realtor.org www.realtor.org

Compiles statistical data on the US housing industry.

US Department of Treasury www.treasury.gov

Publishes quarterly economic statistics and lists calendar of releases.

Bureau of Economic Analysis www.bea.gov

Publishes data on US national, regional, and state levels and allows you to compare the US with economies around the world.

¶21-630 Sector rotation Sector rotation refers to the process of moving equities from one industry sector to another in line with the present phase of the business cycle. Typically, investors switch from industry groups expected to underperform over the next three to nine months to those expected to outperform. Websites with information on sector rotation Website

Services

Australian Stock Exchange www.asx.com.au/products/gics.htm

Provides information about S&P/ASX Global Industry Classification Standard sector indices.

S&P Dow Jones Indices au.spindices.com/indices/equity/sp-asx-200

Measures the performance of the Global Industry Classification Standard sectors and sub-industries.

StockCharts.com www.stockcharts.com

Another US-based website that provides sector charting facilities showing where certain sectors are in the economic cycle and the order in which they should get a boost from the economy.

Sector Rotation Superior Returns Research Group A US-based website that explains the basics of sectorrotation.com sector rotation, provides insights into the information strategic professional traders are sharing and considers how the markets may unfold.

INTERNATIONAL INVESTING ¶21-700 International investing online Most private investors intending to diversify their investment portfolio to include international equities do so via managed funds. This is largely due to the complexities of direct international investing, such as a lack of information, currency risk, taxation implications and higher transaction and holding costs. However, for those who wish to invest directly, the internet has made it much easier. In more recent years, the proliferation of exchange traded funds (ETFs) has helped provide an alternative to manage funds for those wishing to invest in international equities. While investing directly in international shares remains too complex for most investors, there are now a number of ETF products listed on the ASX that are accessible via a regular share trading account. Using these, investors now have the ability to gain exposure to global equities through a single ETF, or, alternatively, obtain more targeted exposures based on a specific sector, region or country, all of which can be traded through an online broker. ETFs are discussed in more detail in ¶21-900.

¶21-710 International stock exchanges A great place to find information about potential investments is each country’s stock exchange website. Here investors will find stock quotes, company fundamentals, charts, news, analyst information, IPO information, portfolio tools, market information, company announcements and statistics. Two websites that provide links to stock exchanges from around the world are: • Stock Exchange Worldwide Links: www.world-stock-exchanges.net, and • Wikipedia: en.wikipedia.org/wiki/List_of_stock_exchanges.

¶21-720 Investing in US securities US investment news and research services Website

Services

Bloomberg www.bloomberg.com

Provides market data, news, commentary, charts and analysis.

Forbes www.forbes.com/investing

Covers a wide range of investment topics.

MSN Money www.msn.com/en-us/money/markets

Provides stock and market commentary, a stock screener, quotes, charts and many other features.

The Street www.thestreet.com

Features news, commentary and investor tools.

Schaeffer’s Investment Research www.schaeffersresearch.com

This website is packed with investment information, especially for option traders, including quotes, market commentary, tools, indicators, and national and international market news.

Trading Markets tradingmarkets.com

Provides investors with all the necessary tools to identify investment opportunities in the US securities markets.

Stock Selector www.stockselector.com

Includes useful stock screening tools allowing investors to find stocks matching their criteria.

Briefing.com www.briefing.com

Provides independent live market analysis of the US and international equity markets.

Zacks Investment Research www.zacks.com

Provides tools to help investors successfully manage the investment process.

Marketocracy www.marketocracy.com

Tracks, analyses and evaluates the trading strategies of the world’s best investors.

Value Line www.valueline.com

Provides independent investment analysis. Best known for the Value Line Investment Survey, one of the most widely read investment services in the world.

US stock charting facilities Website

Services

Big Charts bigcharts.marketwatch.com

Provides free access to interactive charts. Users can view the chart within the preferred time frame, compare securities, overlay moving averages and view up to three technical indicators at one time.

Stock Charts www.stockcharts.com

This US website provides excellent charting facilities, including candlestick, and point and figure charting. The chart school section offers a useful outline of technical analysis.

US investment chatrooms Website

Services

Silicon Investor www.siliconinvestor.com

US stock investment chatroom.

Stockaholics stockaholics.net

Ask questions and get help on the forum and share your opinions.

OnlineTradersForum.com www.onlinetradersforum.com

Chat, competitions, education, analysis and more.

¶21-730 Investing in European securities European news, quotes and research websites

Website

Services

Euroland www.euroland.com

Provides international investors with stock information from various European stock exchanges. The website allows investors to make cross-border selections and compare companies as if they were all quoted on one exchange. Investors can also convert all values to their preferred currency.

Corporate Information www.corporateinformation.com

Lists company details from around the world. Investors will also find a tool, titled “Top 100 lists”, allowing them to view the top 100 companies ranked by various criteria, including market capitalisation, sales and 52-week price change.

EuroMoney www.euromoney.com

Financial and economic news subscription service.

Thisismoney.co.uk www.thisismoney.co.uk

Leading UK finance website written in jargon-free language.

UK Motley Fool www.fool.co.uk

Provides a wealth of information regarding investments, including news, stock quotes, strategies and education.

European stock charting facilities Website

Services

Live Charts www.livecharts.co.uk

Provides stock market charts, commodity trading charts and forex live charts. In addition, the website also provides historical data and stock market message boards.

ADVFN au.advfn.com

Free European stock quotes and charts.

¶21-740 Investing in Asian securities Asian quotes, news and research websites Website

Services

irasia.com www.irasia.com

Provides investor relations material from thousands of companies in the Asia-Pacific region, including annual reports, press releases, analyst commentary and stock quotes.

Money Control www.moneycontrol.com/StockMarketIndian.com www.stockmarketindian.com/

Stock quotes and news on markets in India.

Financial Times — Asia www.ft.com/world/asia-pacific

One of the world’s leading business news and information organisations.

Asia Business Daily wn.com/asia_business_daily

Provides a comprehensive business news service on various Asian industry sectors, including science, technology, media and energy.

ADVANCED INVESTING ¶21-800 Introduction Each year more investors are taking advantage of derivative market products, which may be traded for hedging or speculative purposes. The advantage of derivatives is leverage but, unless managed appropriately, losses can be devastating. Investors must be clear about the risks involved and have the discipline to follow precise money management rules. Derivatives are briefly discussed at ¶9-335 to ¶9-340.

¶21-810 Futures Website

Services

Macquarie Futures www.macquarie.com/au/corporate/ trading-and-hedging/futures

Provides futures trading services including clearing, research, recommendations and technical analysis.

Australian Stock Exchange www.asx.com.au/prices/asx-futures.htm

Provides educational material about futures, futures prices and trading information.

Futures Mag www.futuresmag.com

Provides information and trading strategies for derivatives markets.

¶21-820 Warrants Website

Services

Australian Stock Exchange www.asx.com.au/products/warrants.htm

Includes educational information, warrant price quotes, calculators, news about recent developments in the warrant market, trading information and a comprehensive list of current warrants on issue.

CitiWarrants au.citifirst.com

Provides equity-linked financial products, equity risk management and liquidity solutions for investors and intermediaries.

Westpac www.westpac.com.au/personal-banking/ investments/instalment-warrants

An issuer of instalment warrants, including SelfFunding Instalments (SFIs) and Vanilla Instalment Equity Warrants (VIEWs).

UBS investmentsau.ubs.com/products/warrants%3Dmarketgrowth

UBS is an instalment warrant issuer specialising in Rolling Self-Funding Instalments, Market Growth Instalments and Capped Instalments.

ANZ Share Investing www.anz.com.au/personal/investing-super/onlineshare-investing/

Provides access to warrants with research and tools from Australia’s leading warrant issuers, including Citi and UBS.

¶21-830 Options Website

Services

Australian Stock Exchange www.asx.com.au/education/options-courses.htm

Provides educational material, option prices, trading information, options statistics, and

valuation and modelling tools. Peter Hoadley’s Options Strategy Analysis Tools www.hoadley.net/options/options.htm

Peter Hoadley has developed a number of options trading tools for investors.

ANZ Share Investing www.anz.com.au/personal/investing-super/onlineshare-investing/

Provides option trading tools such as payoff diagrams, options finder tool and options pricing tool.

Optionetics www.optionetics.com.au

Provides investment education services, portfolio management techniques, market analysis and online trading tools.

Binary Options Australia www.binaryoptionsaustralia.com

Brings in-depth and informative articles that help binary option traders make informed decisions about trading in binary options. The website also lists a number of binary options trading sites and brokers.

¶21-840 Contract for difference A contract for difference (CFD) mirrors the performance of a share or index, and is traded on margin. Just like physical shares, the investor’s profit or loss is determined by the difference between the price they buy at and the price they sell at. The main benefits of CFDs is that they allow investors to leverage at little upfront cost and make money in falling markets by short-selling. However, as this is a leveraged product, risk management is essential. Website

Services

IG Markets www.ig.com/au

Deals in share CFDs, stock indices and FX contracts at the genuine market price. Traders can trade through a browser or through a phone app. IG Markets also offers live market news, charting facilities and research.

First Prudential Markets www.fpmarkets.com.au

Provides guaranteed market prices and trading platforms through browsers and phone apps.

CMC Markets www.cmcmarkets.com.au

Offers an easy to use trading platform, market leading pricing, charting with over 80 technical indicators, 100% automated execution, custombuilt apps and personalised client service and trading support.

City Index www.cityindex.com.au

Allows investors to trade the full range of financial markets in locations such as Asia-Pacific, US, United Kingdom and Europe.

EXCHANGE-TRADED PRODUCTS ¶21-900 Exchange-traded funds Exchange traded funds (ETFs) are the most popular type of exchange traded product (ETP) traded, and one of the fastest growing investment products in the world. Similar to traditional managed funds, ETFs are an investment fund that own assets, however unlike managed funds which are unlisted, ETFs trade on the stock exchange in a similar manner to shares in a listed company. Traditional ETFs, commonly known as passive ETFs, are index funds that aim to track the performance of a commodities specified index or benchmark as closely as possible. To achieve this, the ETF invests in a

basket of assets that either match the investments of the relevant index or uses a method of close sampling, thereby replicating its performance. The benefits of ETFs include: • diversification — ETFs are an easy way to achieve instant diversification across an index or market sector. • low cost — ETFs have low fees, as they are not actively managed. • easily traded — ETFs can be bought and sold on the Australian Stock Exchange just like an ordinary share. As such, investors can track the value of their investment on an intraday basis, purchase ETFs on margin or short sell. • tax efficient — the amount of capital gains tax is generally kept low, as ETFs generally have low portfolio turnover. • minimum investment — there is no minimum investment amount for ETFs, in contrast with managed funds which often have a minimum amount requirement. ETFs can be used for hedging, market timing strategies, tactical asset allocation and long-term investing. Website

Services

Australian Stock Exchange www.asx.com.au/products/etf/managedfunds-etp-product-list.htm#9125-content

A complete list of all Australian ETFs listed on the ASX.

MoneySmart www.moneysmart.gov.au/investing/ managed-funds/exchange-traded-funds-etfs

Provides information about ETF types and things to know before investing.

Vanguard Investments As an index manager, www.vanguardinvestments.com.au/retail/ret/investments/product.html#/etf Vanguard’s aim is to deliver the index return, before fees, by building investment portfolios using similar assets and weightings as the benchmark index. This means an ETF’s returns, before costs, should closely match the index it tracks, just like a traditional index managed fund. BlackRock iShares www.blackrock.com/au/individual/ ishares

There are over 360 iShares listed on major stock exchanges in countries around the world, including the US and Australia.

BetaShares www.betashares.com.au

BetaShares offer a broad range of ETF products that cover equities, cash, currencies, commodities and alternative strategies. Their range includes a number of synthetic ETFs, in addition to the more common physical ETFs.

SPDR ETFs www.spdrs.com.au

SPDR ETFs, by State Street Global Advisors, offer a range of traditional index ETFs as well as smart beta ETFs. All SPDR ETFs in Australia are backed by physical assets, with no synthetic exposures used.

Morningstar www.morningstar.com/etfs.html

The US-based Morningstar website hosts an ETF centre, with ETF analysis, screening tools and discussion board.

ETF Trends www.etftrends.com

ETF Trends incorporates ETF research performed by asset managers at Global Trends Investments. The website features educational news stories on specific offerings, market trends, sectors, economies, and ETF market sentiment.

¶21-910 Investing in ETFs Useful resources for assessing and constructing ETF portfolios Website

Services

Vanguard Investments www.vanguardinvestments.com.au/ adviser/adv/home-page.html

Allows registered users access to Vanguard’s portfolio builder tool, which gives the ability to construct, compare and demonstrate portfolios of funds, shares and ETFs.

BlackRock iShares www.blackrock.com/au/intermediaries/ resources/tools

Access to BlackRock’s Portfolio Manager and Portfolio Compare tools which are integrated with Morningstar data and research to aid with construction and comparison of portfolios.

SPDR ETF ED etfed.spdrs.com.au

An ETF education website by State Street Group Advisers that offers a range of courses to assist with evaluating ETF products and constructing portfolios.

¶21-920 Smart beta As the ETF market has developed over time, so too have the strategies employed by some ETF products, giving rise to the concept of “smart beta” ETFs. Smart beta strategies — also known as strategic beta, advanced beta or alternative beta — attempt to achieve a better risk and return outcome relative to traditional indexes. While smart beta ETFs are still index-linked investments, rather than adopting the conventional index approach of weighting investments by market capitalisation, they instead apply a tilt based on specific factor exposures. The most common factor-based approaches include:

• value investing • growth investing • small-cap investing • country and sector-focused • dividend-focused • sector-specific • style-specific • country-specific. Proponents of smart beta ETFs believe they provide low-cost entry to specific investment tilts that were previously only available through more expensive actively managed funds, however, investors should always assess the effectiveness of the strategy in light of the higher costs involved. Useful websites for understanding smart beta ETFs Website

Services

S&P Dow Jones Indices us.spindices.com/regional-exposure/asiapacific/australia

A useful site that explores a number of different topics on smart beta.

SPDR ETFs www.spdrs.com.au/theme/smartbeta.html

Includes a number of smart beta specific tools, explaining the main factors targeted by smart beta methodologies.

BlackRock iShares www.ishares.com/us/strategies/smart-beta

A suite of useful tools and strategies for investing in smart beta ETFs.

FINANCIAL PLANNING ONLINE ¶21-950 Financial planners and the internet Technology has a significant impact on the financial planning industry. Not only has technology changed the needs of financial planning clients (¶21-960), it has also changed how financial planners work (¶21970) and compete in the market (¶21-980). The internet also provides useful tools and calculators that can be used by financial planners and their clients, and access to other financial planning resources (¶21995).

¶21-960 Client needs today Digital technology is a strong driver of change for many industries, including financial planning. With the innovations we have seen in financial services, more investors are becoming self-reliant, as they are able to easily find financial planning resources online to help them understand investment strategies and advice. This has changed the needs of financial planning clients, which can be grouped according to their life stage. • Generation Z. This group is most familiar with life viewed from an online perspective. They are impacted by “influencers”, who tend to have a short-term focus on the need to stay “relevant”. Generation Z are mostly university educated, engage visually and prefer a collaborative approach to learning. They embrace authenticity, tolerance and social responsibility. They enjoy the freedom associated with a “gig economy”, with freelance digital roles providing global employment

opportunities. Welfare issues include the absence of sick leave, insurance and superannuation. They understand the need to save. They value regular employment and apply a prudent approach to spending. This generation is very keen to plan their financial future early, with money matters causing the most stress. Social media marketing provides an effective means for engagement with Generation Z. • Generation Y. This generation is the most tech-savvy, but also lacks financial discipline with a “want it now” and “everything will be OK” attitude, plus a high amount of debt. Generation Y clients provide financial planners with ample opportunities to help them build a solid financial base. They are likely to have a high disposable income, as many live at home with their parents well into their 20s, have few financial commitments, are not afraid of change or taking risks and are keen savers. While Generation Y clients are generally interested in financial education to help them manage their money, financial planners need to allow for collaborative decision-making and enable their Generation Y client to track their success, as this generation does not blindly follow authority. In addition, as this generation will often have multiple jobs and career breaks, they need flexible strategies. Many prefer to educate themselves online and contact a financial planner for additional help. As such, online calculators, webinars, plus low-cost budgeting and investment selection advice is well suited to Generation Y clients. • Generation X. Generation X clients are also web-aware and tech-savvy, as they have grown up in the computer age. They place strong demands on financial planners and are likely to expect more than a yearly visit to review their investments. Generation X clients are not afraid to try out new things, such as sophisticated tax planning strategies or investing aggressively in high growth investments. Financial planners must be prepared to accommodate such investment objectives and will find that unless their recommended investments perform adequately, they will need to go through a lengthy explanation process on a regular basis. Some clients might start to think twice about allocating further funds when investment performance disappoints. • Retirees. A surprising aspect of internet user survey results is the number of seniors who regularly use the internet. Some argue this is not so surprising, as retirees have time to “surf the web” and some have learned enough to do their own investing. However, at this stage most retirees continue to value the services of a financial planner. Keeping up with your client While some clients are overwhelmed by the volume of information available online, many embrace it as an exciting opportunity. Such clients and new prospects, particularly Generation X and Y clients, will be more informed and demand a more active role in the financial planning process. Although the days where clients passively hand over their life savings to a third party are numbered, this does not mean clients do not want advice. What is changing is the nature of the relationship with the financial planner, with financial planners being sought to add value in the planning process and provide a “sounding board”. So how can financial planners add value for generation X and Y clients, who are looking beyond help with money management? One way is by developing a deeper understanding of a client’s needs and issues to determine their lifestyle expectations and desires and adopting the role of coach and mentor to guide clients into better money management behaviour. Some tips on achieving this are outlined in ¶21-970.

¶21-970 The evolving financial planning business Today most financial planners use the internet to improve their business practices. For instance, it is common practice to communicate via email, research financial products and investments online and embrace social media. Other recent developments in financial planning are online do-it-yourself financial planning businesses that use software to produce the same results as a traditional financial planner, but at much less cost. While some financial planners might see such technology as a threat, it is actually an opportunity to

implement scalable advice by spending more time on high-value clients while using software to service lower-value clients in a cost-efficient way. Embracing social media Increasingly, financial planning clients are using social media as a source of investment information. According to LinkedIn, 75% of Australia’s high-net-worth individuals are using social media for information. This means that it is important for financial advisers to add social media to their traditional forms of communications, allowing them to reach prospects and clients where they are active and build relationships on their terms. While using social media to engage clients may be a differentiator today, it will not be long before it is the norm. Some ways financial planners can leverage social media include: • using social media to distribute thought-provoking content in an engaging way to help increase clients’ financial literacy. For example, by using videos, blogs and case studies. This can showcase the financial planner’s intellectual capital and promote their brand. Provide thought-provoking and engaging content to clients and consumers to increase financial literacy within Australia • joining social discussions to connect with prospects and clients. Not only will financial advisers gain insights into how to improve their client services, they can also potentially win over detractors and increase brand awareness • join industry groups to learn from and collaborate with peers • financial planners can learn more about their clients by viewing their social profiles and using the information to inform their financial plans. For instance, is the client interested in buying their own home or are their children leaving for university? By knowing their clients better, financial planners can help them plan better. Hosting a website It is important for financial planners to constantly demonstrate their value as advisors to clients. One way this can be achieved is by hosting a website. The advantages of hosting a business website include: Business promotion Having a website allows financial planners to promote their business to new and existing clients. Potential clients can use the financial planner’s website to find out about the services offered and can make contact. For example, the Select Adviser website at www.selectadviser.com.au is an online directory that helps people find a financial planner. Clients can review their advisers and tell stories about their experience with a particular adviser. Improving service levels Financial planners can improve service levels by placing their client’s financial profiles on the internet and asking clients to fill out their profile before the initial meeting. This allows the financial planner to address hidden concerns and ask more meaningful and probing questions. They may even choose to provide clients with their own personal customised website that includes their financial plan that can be updated at any time. Reduce administrative costs Financial planning is a paperwork intensive business, and the internet can help reduce administrative costs. For example, clients can perform tasks such as changing their address and requesting brochures and other information over the internet. Allowing clients to access their account details and other information online reduces some of the mundane tasks of answering standard queries and frees up the financial planner and support staff to concentrate on more productive and people-orientated tasks. Improve the client/adviser relationship The internet can facilitate a “high-touch” service for valuable clients, strengthening the client/adviser relationship. For example, clients can post queries on the internet that are answered by the financial planner the next day. Financial planners can also send a draft financial plan via email, providing the client

with more participation in the financial plan construction stage. Likewise, financial planners can masscommunicate with passive clients via the internet to demonstrate the value of their services. For example, ensure your clients are on track to achieve their financial goals by using an automated follow up reminder system and provide clients with access to tutorials, techniques and tools to improve their finances. Scalable advice Not everyone needs or can afford face-to-face financial advice. This means financial planners may be missing out on potential clients who would prefer to receive low-cost limited advice online. Such facilities allow customers to use calculators and self-assessment tools to help them make financial decisions, followed up with a generated Statement of Advice. Online financial advice tools can be purchased and hosted on the financial planner’s website, for example, take a look at AdviceConnect, found at www.adviceconnect.com.au. Financial planning websites that work Since a business website can be a pivotal tool in attracting and keeping clients, it is important to ensure it meets the client’s needs. For instance, clients who access the website are likely to require financial education and would also look to conduct investment research, evaluate their existing strategies and choose the right products. Existing clients may also require tools and transaction capabilities to manage their investments. The following websites provide examples of the types of financial planning tools being made available over the internet. Website

Services

Kiplinger.com www.kiplinger.com/fronts/archive/tool/index.html

Provides information about investing, planning and spending money in the US. There are also a range of tools to help investors make financial decisions.

CBC Financial Advisors www.cbc.com.au

Although CBC is a small suburban firm, it has an excellent website. Some of the features include a mobile site option and a dedicated login for clients showing the live value and performance of their portfolios at any time.

CNNMoney.com money.cnn.com/retirement/

Features news, special reports and long-term strategies on saving for retirement in the US.

The Motley Fool www.fool.com.au

A website that aims to educate, amuse and enrich through investing news and commentary, a free newsletter and subscription-based services.

Financial Engines financialengines.com/

Offers online financial plan preparation for US residents.

Choose to Save www.choosetosave.org

Choose to Save is a US award winning public education and outreach program, dedicated to raising awareness about the need to plan and save for long-term personal financial security. Investors can access multimedia materials to help them plan and save, such as interactive planning worksheets and online calculators.

Plan & Act www.planandact.com

Provides fast, affordable and independent online financial planning advice. Plan & Act is also a feeonly service based in the US.

¶21-980 Competition with other financial service providers

The internet can play an important role in helping investors make decisions through the use of interactive tools and financial planning education. Financial services institutions, such as banks, fund managers and superannuation funds, use the internet to offer financial information and products directly to investors. They also provide retirement and investment planning information. Already, many websites provide investors with “live help” services and calculators, allow investors to change their personal details and investment strategies online, and make personal contributions through services such as BPAY. Continual innovation may change the role financial planners play in the investment process, especially if ecommerce facilitates fund manager interaction directly with customers.

¶21-990 Robo-advice Robo-advice provides automated financial advice online and is usually used to cover one particular advice area, such as selecting between superannuation investment options. A robo-adviser, such as a superannuation fund, needs to hold an Australian financial services (AFS) licence. While fees for this type of advice might be lower, individuals will need to assess total costs and overall benefits. Website

Services

Money Smart Robo-advice www.moneysmart.gov.au

Government website that provides free and impartial financial guidance and tools.

finder www.finder.com.au/robo-advice

Robo-advice comparison finder

¶21-995 Online financial planning resources The following websites provide useful resources for financial planners. Website

Services

CCH Australia www.wolterskluwer.cch.com.au

CCH’s Financial Planning Navigator provides a complete online financial planning reference manual with commentary on topics such as superannuation, taxation, social security, compliance, estate planning and much more. A subscription is required.

Financial Planning Association fpa.com.au

Represents the interests of the public and Australia’s professional community of financial planners.

Australian Taxation Office www.ato.gov.au

Provides a range of calculators on superannuation, tax and business.

Money Smart www.moneysmart.gov.au

Provides access to the calculators for superannuation, managed funds, risk and return, compound interest, budgeting, credit cards, loans, retirement, pensions, reverse mortgages and a DIY statement of financial position calculator. It also keeps a financial advisers register, allowing potential clients to find out an adviser’s qualifications and what products they can advise on. It also includes a financial toolkit designed especially for women.

AMP www.amp.com.au

Provides a wide range of calculators, including loan, insurance and investments. Also provides a superannuation and retirement simulator.

Infochoice.com.au www.infochoice.com.au/calculators

Provides home loan, investing and savings calculators.

Macquarie Bank www.macquarie.com/au/personal

Provides calculators on loans and superannuation.

Australian Stock Exchange www.asx.com.au/prices/calculators.htm

Access warrant, options, SFE, CFDs and bond calculators.

Your Mortgage www.yourmortgage.com.au/calculators

Provides a range of property-related calculators, such as rent versus buy and stamp duty.

The Association of Superannuation Funds of Australia www.superannuation.asn.au

The industry body for Australian superannuation funds.

SMSF Association www.smsfassociation.com

An association committed to raising industry standards and looking after the needs of selfmanaged super fund professionals across Australia.

CPA Australia www.cpaaustralia.com.au

Education, training, technical support and advocacy for members.

The Institute of Chartered Accountants Australia www.charteredaccountantsanz.com

The Institute represents accounting and business professionals in Australia and around the globe. Members strive to uphold financial integrity through a commitment to ethics and acting in the public interest.

Australian Securities and Investments Commission A government body that aims to, among other www.asic.gov.au things, maintain, facilitate and improve the performance of the financial system and entities in it and promote confident and informed participation by investors and consumers in the financial system. Services Australia www.servicesaustralia.gov.au

Services Australia is responsible for the development of service delivery policy and provides access to social, health and other payments and services.

TECHNICAL ARTICLES ¶22-000 Reconsidering incorporated contractors By Daniel Butler, Director and Rebecca James, Special Counsel, DBA Lawyers (February 2016) Introduction This article considers when a contractor falls within the superannuation guarantee (“SG”) regime and in particular, in what circumstances are SG contributions required to be made on behalf of an individual engaged by an incorporated contractor to avoid a shortfall under the Superannuation Guarantee (Administration) Act 1992 (Cth). This article will also consider the legislative provisions and key Federal Court decisions, as well as providing practical guidance on the application of the SG regime to incorporated contractors. Background Definition of an employee For the purposes of the SGAA, an employee is defined in s 12 as a common law employee and a worker that falls within the expanded definition of an employee, which includes a person that works under a contract that is wholly or principally for their labour (s 12(3) of the SGAA). What is a contract for labour? In determining whether a contractor works under a contract that is wholly or principally for their labour, it is important to first consider what constitutes a contract for labour. The Commissioner of Taxation (“Commissioner”) has outlined his view on when a contract for labour will be held to exist in Superannuation Guarantee Ruling SGR 2005/1 — Superannuation guarantee: who is an employee? (“SGR 2005/1”). The Commissioner will look at the following three key factors. Is the contractor remunerated (either wholly or principally) for their personal labour and skills? For example, does the contractor supply tools, equipment or materials and if so, what is the value of the tools or equipment provided as a proportion of the total fee or amount received. If the fee for hiring similar equipment in comparable circumstances would equate to more than 50% of the fee for the particular job, this factor would suggest that the contractor is not in fact remunerated wholly or principally for their personal labour and skills. Further, does the contractor engage employees or subcontractors that the contractor is responsible for remunerating? Is the contractor required to perform the work personally, such that there is no right of delegation? Importantly, if there is a right of delegation under the contractor agreement, is it a genuine right, and does the contractor exercise this right in practice? In the case of Neale (Deputy Commissioner of Taxation) v Atlas Products (Vic) Proprietary Limited (1955) 94 CLR 419 at 424–425, the court formed the view that the right of delegation under the contract was a genuine right that the contractor could exercise, despite the fact that it had not been exercised to date, and therefore (based on this factor and various other factors), the worker engaged was an independent contractor. In our experience, it is not uncommon for the Commissioner to seek to argue that the right of delegation must be an unlimited or unrestricted right of delegation, such that if the principal requires any subcontractor engaged by the contractor to have adequate education, training or experience, the right to delegate is effectively discounted or afforded less weight in determining whether the contractor is in fact an employee for SG purposes. However, this interpretation adopted by the Commissioner is not in fact supported by case law and highlights the difficulties principals can face when trying to assess whether SG contributions should be made on behalf of a worker who wishes to be engaged as an independent

contractor. It is not uncommon for incorporated contractors to be engaged under an independent contractor agreement and for a key person who is required to provide the services to the principal to also be a party to the contractor agreement. In this circumstance, the key person of the company has a legal obligation to provide the specified services to the principal and the principal has corresponding legal rights in respect of non-performance by the key person. The difficulties that arise when contractor agreements are structured in this manner is discussed in greater detail below. It is also not uncommon for principals to seek to equate delegation with the reallocation of work among a pool of contractors. It is important to remember that effective delegation requires the contractor to be legally responsible for remunerating the person or entity to whom the work is delegated. It is not sufficient for a contractor to arrange for another entity to undertake the work, where the obligation to remunerate the entity continues to rest with the principal. Thus, for delegation to be effective, the contractor would accept the particular job and then resource the job by delegating the tasks required to achieve the specified outcome to a sub-contractor for example. In this scenario, the contractor is legally liable for the fees it has agreed to pay to the sub-contractor, as well as any other applicable legislative requirements, such as workcover premiums. Similarly, the principal continues to be liable to pay the agreed fees to the contractor for the completion of the agreed job. Is the individual paid to achieve a result? The Commissioner will consider whether the contractor is engaged and remunerated to produce a result, or if they are remunerated for their efforts. While the payment structure is not determinative (ie whether the contractor is remunerated hourly, or at a fixed rate per assignment), it is likely to indicate whether the contract is a contract for service as opposed to a contract of service (being an employment contract). Can a company be engaged under a contract for labour? It is commonly understood to be the case that a company cannot be a common law or deemed employee for SG purposes. This view has been confirmed by the Commissioner in SGR 2005/1 at paragraph 13 as follows: “Where an individual performs work for another party through an entity such as a company or trust, there is no employer-employee relationship between the individual and the other party for the purposes of the SGAA, either at common law or under the extended definition of employee. This is because the company or trust (not the individual) has entered into an agreement rather than the individual. However, the individual may be the employee of the intermediary company or trust, depending on the terms of the arrangement.” However, it is important to keep in mind that SGR 2005/1 is not binding on the Commissioner and represents the Commissioner’s thinking 10 years ago, and that the law in this area has continued to advance. In light of this background, we now consider how the courts have treated incorporated contractors for SG purposes. Incorporated contractors Roy Morgan Research Pty Ltd v Commissioner of Taxation In the case of Roy Morgan Research Pty Ltd v Commissioner of Taxation [2010] FCAFC 52 (“Roy Morgan Research”), it was found that some interviewers were engaged under the name of a company. It was held that while incorporation was a relevant factor, it was outweighed by other factors. Ultimately, the fact that an interviewer was incorporated carried little weight because the entity selected to conduct the interviews was the individual interviewer, and the company featured only as the recipient of the fees. This case highlights the issues involved in engaging a company, but requiring a key individual to perform the relevant services. Further, incorporation by itself is not sufficient to take a worker outside the scope of the SG regime where they would otherwise be caught. Thus incorporation was considered to be merely

one factor to be taken into account and weighed in light of the totality of the circumstances. It is not a “silver bullet” that automatically ensures a contractor is outside the scope of the SG regime. ACE Insurance Ltd v Trifunovski In Ace Insurance Ltd v Trifunovski [2011] FCA 1204 (“Ace Insurance”), the Federal Court considered the status of insurance agents. In this case, all of the contracts permitted the agents to operate, if they chose, through a corporation. As sub-regional representatives, Mr Peries and Mr Trifunovski did at certain times conduct their operations through their respective companies. However, despite these arrangements, the services were provided by Mr Peries or Mr Trifunovski. The Australian Financial Services (“AFS”) licence required the individuals to be authorised by the relevant AFS licence holder. This was an important factor in the ultimate decision of the Federal Court. The Federal Court followed the decision in Roy Morgan research, stating that: “In substance, the corporate vehicle merely allowed the commissions to be received by the companies and for the incurring by them of expenses. As the Full Court noted in Roy Morgan Research at 464 [43] the Tribunal in that case had committed no error in giving this matter little weight when ‘the entity selected to do the work … was the individual interviewer, and the company featured only as the recipient of the fees that would otherwise have been paid to the interviewer.” Thus the Federal Court held that a similar conclusion applies in this case as the incorporated contractor merely featured as a payment mechanism for the receipt of fees and payment of expenses. The Federal Court took the view that the relationship between the engaging entity and the company was not in substance a principal/independent contractor relationship. As a result of the Federal Court decisions in Roy Morgan Research and Ace Insurance, it is crucial to consider which entity in practice is actually being engaged to perform the relevant services. It is not sufficient to simply engage an incorporated entity under a contractual arrangement — it is still necessary to consider each factor in determining whether the contractor (or key person) falls within the scope of the SG regime, as the courts will consider the substance of the relationship between the relevant parties in discerning the relationship. The principal and contractor “cannot create something which has every feature of a rooster, but call it a duck and insist that everybody else recognise it as a duck” (Re Porter; re Transport Workers Union of Australia (1989) 34 IR 179 at 184). There is a risk that where a contractor operates via a company, but the dealings are in substance between the principal and a key person rather than the company, and the following factors are present: • the individual operates in all material respects as an individual, such that any fee received is in substance a payment principally for their labour • the company undertakes little other business activities or minimal other clients apart from providing services to the principal, and • the company does not have any substantial business operations, equipment or any goodwill, it may result in a court being willing to ignore the corporate structure. In contrast, where an incorporated contractor has numerous employees, substantial equipment, business systems and goodwill, it is unlikely that payments to such a contractor will be deemed to be a payment to an individual engaged by the contractor. It is commonly understood that a payment to a contractor that operates via a company is not covered by the SG regime. However, as the analysis above suggests, this is not a safe position to rely on without a more detailed examination of the overall circumstances to see if, in substance, the arrangement is primarily for an individual’s labour. As the cases outlined above demonstrate this area of the law is complex and difficult to apply in practice. As Bromberg J noted in On Call Interpreters and Translators Agency Pty Ltd v Federal Commissioner of Taxation [2011] FCA 366: “the absence of a simple and clear definition which explains the distinction between an employee and

an independent contractor is problematic …. Workers and those who employ or engage them require more clarity from the law. That is particularly so when important legislation such as the Fair Work Act (and its predecessors dating back to 1904) have steadfastly avoided defining what is an employee, yet demand (on pain of civil penalty) that there be no misrepresentation as to the nature of the work relationship: see s 357 of the Fair Work Act.” What are the risks of getting it wrong? We now examine what happens if the parties get it wrong. It is not uncommon for parties to intend to enter into a contractor arrangement, and for the ATO or the courts to find that irrespective of each party’s intention, the relationship is in fact an employment relationship. We outline the consequences that may follow below. As the law currently stands, when a principal fails to make SG contributions on behalf of a contractor that is a common law or deemed employee for SG purposes, the principal is liable for the superannuation guarantee charge (“SGC”), which is calculated as follows: • a shortfall amount determined by multiplying the employee’s total salary or wages (rather than just their ordinary time earnings (“OTE”)) against the charge percentage (currently set at 9.5% for the 2016 income year) • an administration fee of $20 per quarter per employee, and • interest at 10% on the shortfall amount from the beginning of the quarter in which the contribution was required to be made (ie 1 January) until the later of the lodgement of a SG statement outlining the shortfall amount or the 28th day of the second month after the end of the relevant quarter (ie 28 May for the quarter ending 28 March). Principals may also be liable for: • a penalty of up to 200% of the SGC amount under Pt 7 of the SGAA (however, the government has introduced draft legislation that proposes to remove this penalty) • a penalty of up to 100% under the Taxation Administration Act 1953 (Cth) • a choice of fund penalty up to $500 per quarter per contractor, and • an amount equal to the SGC personally if the Commissioner issues a director penalty notice. There is a defence to personal liability that applies specifically to contractors, where the principal believed the contractor was a genuine independent contractor for SG purposes, and this belief was reasonable in the circumstances. However, this defence has not been tested to date, so it is unclear how the courts will apply the defence in practice. These penalties can apply irrespective of whether the failure to make SG contributions was an inadvertent mistake or misunderstanding in applying complex legislative provisions. The Commissioner does not have discretion to remit the SGC. This area of the law should be revised in view of the complexity of contractor arrangements that currently exist. Conclusion The inherent difficulty in the SG regime is the uncertainty of the “deemed” employee test and whether a contract is wholly or principally for the labour of the worker. Determining whether a contractor is in fact an employee for SG purposes requires various factors to be weighed up and considered and a decision made on a case-by-case basis. Inevitably, there are factors that suggest a worker could be both a contractor and an employee (either under the common law definition or the expanded definition of employee for SG purposes) and the weighting given to each factor can vary depending on the specific circumstances. Therefore, principals cannot be certain that a worker is in fact an independent contractor merely because the worker is engaged via a company, especially where a key person is required to carry out the services. If there is a SG exposure on any contractor arrangement, the PAYG implications should also be

considered. Moreover, the workcover insurance and payroll tax legislation should also be considered as each area of the law has specific provisions dealing with contractors, even for those that operate via companies. This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.

¶22-005 Traps for SMSF members who keep money in a big fund for insurance By Gary Chau, Lawyer, David Oon, Lawyer and Bryce Figot, Director, DBA Lawyers (March 2016) A desire for some people who exit large funds and start a new SMSF is to leave a portion of their superannuation in the large fund. This is often because it can be relatively simple to retain life, total and permanent disability (“TPD”) and income protection insurance cover in a large fund. While the above strategy broadly works, SMSF members need to be careful of traps in large funds that can cause a loss of cover. This article highlights some of the traps and pitfalls to look out for. Keeping money in a big super fund One of the perceived advantages in keeping a balance with a large superannuation fund is access to low cost insurance that has been arranged “in bulk” by the superannuation fund. Often, no medical examinations are necessary to have access to this cover. Despite any advantages, there can be terms in these insurance arrangements that can cause cover to cease unexpectedly. Some of the circumstances we are aware of are outlined below. No employer contributions At a super fund known to us, if employer contributions cease for six months, a member automatically loses income protection cover. We understand that this is a policy for certain large funds that offer members automatic income protection insurance. In this vein, we are also aware of another large fund where income protection cover ceases after 13 months from the date of the last employer contribution, regardless of account balance. After 12 months (one month before the 13-month period expires), the fund notifies the member that cover is about to cease. Not meeting minimum balance requirements To retain cover at most large funds, the funds usually require that the member maintains a minimum balance in your account. From a review of a number of funds, this can be as low as $1,000 or as high as $10,000. While most large funds let members retain cover as long as premiums can be automatically deducted from their account, we are aware of a fund that will cease insurance cover for life, TPD and income protection when the account balance falls below $1,500 and no employer contributions are made after 12 months. This fund will contact the member to advise that cover will cease. Similarly, we are aware of other funds, including a fund that will cease life, TPD and income protection cover if the member’s account balance is below $2,000 and no employer contributions or rollovers are made for 12 consecutive months. Another fund will cease life and TPD cover six months from the end of the month from which the employer made a contribution to the member’s account and their balance is less than $1,200. No longer working for a particular employer Further, we are aware of a fund that requires that a particular employer (among a group of approved employers) makes contributions to the member account. At this fund, TPD and income protection cover cease without notice if the member is no longer working for that employer after 71 days and their account balance is less than $3,000. No longer working in the corporate body or public sector Some large funds cease insurance cover if the member no longer works with a particular employer or in a particular industry. This is a common feature of corporate and public sector superannuation funds. We are aware of some public sector funds where income protection cover ceases on the day the member officially ceases employment with the relevant public sector. There is also another public sector fund that will cease all cover after 60 days from the last employer contribution or when the member stops working

in the relevant public sector. Additionally, these public sector funds generally do not accept further contributions or rollovers if the member is no longer working for the relevant public sector employer. Membership in most corporate funds is for employees and former employees, and at certain funds this is extended to allow relatives of employees to join. We are aware of a corporate fund that automatically provides employees a corporate cover that would not otherwise be available to non-employees. However, membership at this corporate cover is only available to current employees. Hence, if the member stops working with the relevant employer connected to this corporate fund and does not have a minimum $1,200 balance with the fund, the corporate cover which includes life, TPD and income protection cover will cease 30 days after the member ceases employment. Restrictions on terminal illness payouts We are also aware of a certain fund whereby on terminal illness, the insurance can pay out at the TPD level (or a deemed TPD level), which could be lower than the amount of life cover. This payment reduces any remaining life cover paid on death. The effect of this may be a deprivation of funds to pay for medical or palliative care before death. This method of terminal illness cover stands in contrast to other funds that pay out 100% of life cover upon terminal illness. This style of cover can also give rise to more tax because the beneficiaries will receive the death benefits, as opposed to the member receiving benefits before they die. Staying informed Be aware that some large funds may not give warning when insurance cover is about to cease. Therefore it is important to monitor accounts periodically. Large super funds should have their insurance policies outlined in their insurance guide or product disclosure statement. These policies should be read carefully and any questions should be directed to the super fund for clarification on exactly how insurance cover applies. Insurance in an SMSF If the member no longer wishes to maintain insurance in a large super fund, or is unable to, it is of course possible to maintain certain kinds of insurance in an SMSF. Indeed, the law says that SMSF trustees must formulate, review regularly and give effect to an investment strategy that includes consideration of whether to hold a contract of insurance for one or more members of the fund. This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.

¶22-010 ATO releases safe harbours for non-bank SMSF limited recourse borrowing arrangements By Bryce Figot, Director and Daniel Butler, Director, DBA Lawyers (April 2016) The Australian Taxation Office (ATO) has released important information detailing interest rates, loan-tovalue ratios (“LVRs”) and other terms that constitute safe harbours for SMSF limited recourse borrowing arrangements (“LRBAs”) so that arrangements will be taken to be consistent with an arm’s length dealing. The ATO is officially calling their release a “Practical Compliance Guideline”. Broadly speaking, LRBAs consistent with arm’s length terms should not give rise to non-arm’s length income (“NALI”). On the other hand, LRBAs that are not consistent with arm’s length terms will attract NALI. It is important to note here that many refer to non-arm’s length LRBAs as “related party” LRBAs. However, some SMSFs have obtained loans from unrelated parties such as friends that are not related parties that still fall under the ATO’s target of LRBAs that are not on arm’s length terms. Accordingly, in this article we refer to “non-bank” LRBAs. Accordingly, this ATO Practical Compliance Guideline is critical for: • SMSF trustees that have already entered into LRBAs as action might be required, and

• SMSF trustees that are considering entering into LRBAs, that are not financed by a bank. SMSF trustees that have already entered into non-bank LRBAs might need to revise the terms of the loan or take other timely corrective action by 30 June 2016. In view of the ATO safe harbours, we strongly recommend that a review be undertaken of every LRBA that is not financed by a bank as soon as practicable and in any event prior to 30 June 2016. DBA Lawyers provides advice and documentation in respect of all SMSF matters and we also offer a fixed-fee service to alter the terms of an existing LRBA with appropriate documentation (see www.dbalawyers.com.au/smsf-borrowing-alter-terms). Indeed, there are LRBAs that have insufficient documentation in place that are not consistent with arm’s length terms. Background At the risk of oversimplifying, to the extent that an SMSF has NALI, that income is taxed at a very high rate (47% in the 2016 financial year) even if the fund is in pension mode. When the predecessor of the current LRBA laws (ie the old instalment-warrant exception in the now repealed s 67(4A)) was first introduced in 2007, a question mark was over non-bank loans that have terms that favour the SMSF. In this regard, see ATO Taxpayer Alert TA 2008/5. In 2010 the ATO released ATO ID 2010/162, which considered whether an SMSF trustee contravenes the arm’s length provisions of the Superannuation Industry (Supervision) Act 1993 (Cth) “if it borrows money from a related party of the SMSF under a limited recourse borrowing arrangement on terms favourable to the SMSF?” The ATO answered this in the negative saying that it was not a contravention. Later on, in the December 2012 NTLG minutes, the issue of interest free or low interest loans to SMSF trustees was considered. These minutes record that “ATO ID 2010/162 failed to identify whether any other provisions of the superannuation or tax law would be contravened by the trustee entering into a no interest or low interest limited recourse loan arrangement”. These minutes went on to state: “The ATO position on low rate loan arrangements and LRBA is that that they do not generally invoke a contravention of the SISA, do not give rise to non-arm’s length income under section 295-550 of the Income Tax Assessment Act 1997 (ITAA), do not invoke Part IVA of the ITAA 1936 and are not considered to give rise to contributions to the SMSF just from that one fact alone.” [Emphasis added]” Accordingly, this piqued the interest of some in non-bank LRBAs that favour the SMSF. However, DBA Lawyers has always felt non-bank LRBAs pose risks and NTLG minutes are not binding. Accordingly, we have always cautioned our clients to keep all LRBA terms on an arm’s length basis. In December 2014, the ATO released ATO ID 2014/39 and ATO ID 2014/40 (since replaced — but not practically altered — by ATO ID 2015/27 and ATO ID 2015/28 respectively). These both considered nonbank LRBAs with nil interest being charged and both stated that the ATO’s view is that the arrangements did give rise to NALI. Accordingly, the position that DBA Lawyers had long been in favour of then became broadly well accepted by all in the industry, namely, that non-bank LRBAs should be on the same terms that would be agreed with an arm’s length lender. In December 2014, the ATO released a page on their website (since taken off the ATO’s website, but available at web.archive.org/web/20150322033333/https://www.ato.gov.au/Super/Self-managed-superfunds/In-detail/News/Non-commercial-limited-recourse-borrowing-arrangements) stating: “To be able to demonstrate that NALI does not arise, a fund trustee entering into an LRBA with a related-party borrower should obtain and keep documentation that enables them to establish that the terms of the loan, taken together, and the ongoing operation of the loan are consistent with what an arm’s length lender dealing at arm’s length would accept in relation to the particular borrowing by the fund trustee.” Accordingly, the importance of benchmarking terms of non-bank LRBAs to what, for example, a bank

might offer, was reinforced to the entire industry. However, in a practical sense, benchmarking can be difficult. Accordingly, the ATO safe harbours are a very positive step and the ATO should be commended for developing and releasing them. Terms of the safe harbour The Practical Compliance Guideline states that the ATO: “Will accept that an LRBA structured in accordance with this Guideline is consistent with an arm’s length dealing and that the NALI provisions do not apply purely because of the terms of the borrowing arrangement.” At the risk of oversimplifying, essentially the terms are as follows: Type of asset being acquired

Real property (any kind)

Listed securities

Interest rate

RBA Indicator Rates for banks providing standard variable housing loans for investors (5.75% for the 2015–16 year)

Same as real property + 2%

Term of loan

15 years for original loan (any refinancing will be reduced by duration of the previous loan(s))

seven years for original loan (any refinancing will be reduced by duration of the previous loan(s))

Maximum Loan-to-value ratio

70%

50%

Security

A registered mortgage

A registered charge/mortgage or similar security (that provides security for loans for such assets)

Personal guarantee

Not required

Not required

Nature and frequency of repayments

Monthly repayments on a “principal and interest” basis

Same as real property

Loan agreements

Written and executed

Written and executed

The Practical Compliance Guideline also provides further detailed guidance regarding the specifics of setting interest rates, particularly for fixed versus variable loans. What to do if an existing non-bank LRBA does not meet the safe harbour Advisers should contact all clients with non-bank LRBAs and tell them to read the Practical Compliance Guideline in full. Naturally, this article is just a summary and does not do the Practical Compliance Guideline justice. If the existing LRBA does not meet the safe harbours set out above, the Practical Compliance Guideline provides the follow options by 30 June 2016: • Option 1 — Change the terms so that they are consistent with an arm’s length dealing by 30 June 2016. • Option 2 — Bring the LRBA to an end by 30 June 2016. • Option 3 — Refinance to a commercial lender by 30 June 2016. The ATO also require all non-bank LRBAs to be put on arm’s length terms on or before 30 June 2016. This includes, for example, SMSFs being required to pay a full year’s repayments under loans prior to 30 June 2016. This may place many SMSFs under financial stress given that they only have limited time available to come up with substantial cash funding. Moreover, from 1 July 2016 LRBAs covered by the ATO’s safe harbour will need to make regular monthly repayments of principal and interest. As you would be aware, some non-bank LRBAs may have allowed

more flexible repayments such as only requiring annual payments and some only required full repayment on finalisation of the loan term. The closeness of 30 June 2016 cannot be overemphasised. All advisers (and then SMSF trustees) should act immediately as time is needed to obtaining advice, prepare documents and arrange the cash flow to be obtained and transferred before the 30 June deadline If the 30 June deadline is not practical and is likely to be overshot, then expert advice should be obtained as soon as practical as a special approach to the ATO may be required. Interesting points to note Assets not covered by the safe harbours What should one now make of non-bank LRBAs that are not covered by the safe harbour? First, the safe harbours in the Practical Compliance Guideline only expressly apply to: • real property • a collection of shares in a stock exchange listed company, and • a collection of units in a stock exchange listed unit trust. For example, if an SMSF trustee has borrowed from a non-bank to acquire units in a specific class of units in certain Vanguard managed funds what action should the SMSF trustee take? Many think of such an investment as being tantamount to a listed security, but technically it is not. Perhaps somewhat more controversially, what to do if an SMSF trustee has borrowed to acquire units in a related trust such as a reg 13.22C Div 13.3A unit trust? Given there is no safe harbour available, the ATO’s comments from December 2014 are more important than ever, namely: “To be able to demonstrate that NALI does not arise, a fund trustee entering into an LRBA with a related party borrower should obtain and keep documentation that enables them to establish that the terms of the loan, taken together, and the ongoing operation of the loan are consistent with what an arm’s length lender dealing at arm’s length would accept in relation to the particular borrowing by the fund trustee.” Therefore, the onus is on the SMSF trustee to obtain sufficient and appropriate evidence to support the arm’s length nature of the terms of their LRBA. This may be difficult where there is no readily available market information and quotes and proposals from third parties and other sources may need to be researched and documented. Indeed, some may not wish to continue with a non-bank lender and may prefer to refinance with a bank. Actually calculating the loan-to-value ratio How is the LVR calculated? More specifically, is the “value” of the real property its value excluding GST, stamp duty and other similar costs? In the absence of ATO clarification, the conservative approach is to assume that the answer is yes. The ATO require the market value to be established at the time of the relevant loan. Thus, the market value of the asset will generally be at the time of refinancing or if there is no refinancing at the date of the original loan. Multiple assets for one loan The Practical Compliance Guideline reinforces that it is possible to have multiple loans to acquire one asset. More specifically, it states: “If more than one loan is taken out in respect of the acquisition of the asset, the total amount of all those loans must not exceed [for real property] 70% of the asset’s market value [or 50% for listed securities].” What does “real property” mean?

The Practical Compliance Guideline refers to real property. On first blush it seems to cover all real property, referring to “real property, whether that property is residential or commercial premises (including property used for primary production activities)”. However, there are a lot of ambiguous assets which might be seen as real property or might not be so seen, such as: • A tenants in common interest in real estate — technically this is real property but the ATO do not expressly mention a non-bank lending to an SMSF to acquire a, for example, 50% tenants in common interest in a house using a 70% LVR and a 5.75% interest rate. • Life interests in real estate or listed shares/units — technically this is real property, but similar to tenants in common we doubt whether the ATO would be comfortable with an SMSF using these safe harbours to acquire such an asset. • Shares in a real estate company — there exists “company title” whereby a property does not have a plan of subdivision per se but rather comprises a number of apartments and a company owns all the property and by buying, for example, all of the C class shares the owner of the shares has exclusive possession to apartment number 3. Technically, such shares are not real property. However, there are certain areas of the laws that essentially allows them to be treated as real property (such as the CGT main residence exemption). The conservative position would be to treat such shares in a real estate company as not constituting real estate for the safe harbour relief and apply to the ATO for SMSF specific advice. Do not interpret the safe harbours for something they are not The safe harbours do not state that just because the terms in the Practical Compliance Guideline are satisfied NALI can never occur. Rather, they have the following more restrained comment “an LRBA structured in accordance with this Guideline is consistent with an arm’s length dealing and that the NALI provisions do not apply purely because of the terms of the borrowing arrangement” (emphasis added). For example, if an SMSF acquires an asset for a non-market value from a related party, NALI could apply (refer Darrelen Pty Ltd v Commissioner of Taxation [2010] FCAFC 35). Conclusions The safe harbours are critically important. They are a very practical solution and the ATO should be commended accordingly for its positive manner in managing these non-bank LRBAs. All non-bank LRBAs should be reviewed and appropriate taken by 30 June 2016. This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.

¶22-015 The advantages of conditional membership in an SMSF Contributed by Daniel Butler, Director and Philippa Briglia, Lawyer, DBA Lawyers (April 2016) There can be compelling reasons why one might want to share a self managed superannuation fund (SMSF) with others. However, sharing an SMSF with a spouse (especially a second or subsequent spouse), children, siblings, in-laws, friends or business associates can involve a risk that at some stage there may be a breakdown in the relationship. Have you ever thought what happens when this occurs? Indeed, it is critical that SMSF members cooperate effectively and manage the fund smoothly. This is of prime concern to the member(s) who have the majority account balance(s) in the fund, and who may seek to extricate themselves from a potentially messy legal wrangle. Unfortunately, the law does not adequately provide for such situations. A certain legal “war story” can serve to illustrate the above problems that occurred in a mum and dad SMSF. The facts in Triway Superannuation Fund v FC of T [2011] AATA 302 involve the Triway Superannuation Fund being created and money was transferred to it upon advice given to its trustees by people introduced by the son. The son had a drug addiction and squandered all of his mum and dad’s SMSF retirement savings. The fund was rendered non-complying. The son and his mum and dad, with

assistance from their tax agent, assisted to conceal their son’s contraventions for five years until they were discovered during an ATO audit. Assuming the parents wanted to remove the son from the Triway Superannuation Fund, they did not have a clear right to do so as they would have required their son’s consent. The Triway decision is an unfortunate but good example of how conditional membership can be beneficial. There are numerous other instances listed below where conditional membership can be invaluable. Removing trustees and members So how can a member be removed from an SMSF? The starting point is that it depends on the particular SMSF deed and related documentation. Under DBA Lawyers SMSF deed, the members with the majority account balance can appoint or remove a trustee. This weighting of votes by account balance is particularly advantageous in situations like the Triway case. This means that the member(s) with the majority account balance can remove a person or company as a trustee. Many other SMSF deeds provide the power to the trustees or to the members by headcount. With the vast bulk of SMSFs having two members, this could easily result in a stalemate. In addition to being removed as a trustee or director of a corporate trustee, the SMSF deed must also be examined for the provisions relating to the removal of a member. Most SMSF deeds do not provide any power for a trustee to remove a member once a falling out has occurred. Conditional membership Under the DBA Lawyers SMSF deed, express provision is made to admit members on a conditional basis. The DBA Lawyers SMSF deed allows a “conditional” member to be paid out (if they have satisfied a relevant condition of release) or rolled out to another superannuation fund upon the occurrence of a specific event or upon a specified time. For example, if a member wanted to admit their second spouse as a member but wanted the flexibility of paying or rolling their spouse’s balance in the event of a relationship breakdown, then this event could be specified as one of the conditions on which the second spouse would be removed from the fund. The “conditional” member’s consent would operate such that, upon the occurrence of one or more specific trigger events, the SMSF trustee can use the consent to remove the member and pay their benefit (if a relevant condition of release is satisfied) or transfer their benefit to another complying superannuation fund. Conditional membership therefore operates similarly to an insurance policy — you do not want to have to use it, but if the day comes when you need to, you will be very glad that you had the foresight to put it in place. What type of conditions may be placed on a “conditional” member There are a range of examples that can be considered for giving rise to a right to remove a member, including: • divorce or separation in the case of a de facto relationship • a member fails to attend to their usual trustee/director duties including attending at least four trustee/director meetings • material disagreement which is not resolved within 30 days • where business associates share the same SMSF, and: – their business relationship ceases, or – there is a triggering event under the buy-sell (or equivalent) agreement, as the member(s) with the majority account balance determine, or

• any legal dispute between the parties. SMSF documentation Naturally, appropriate related documentation including disclosures and trustee resolutions should be prepared to document the member’s admission and any special conditions that apply. Under most other supplier’s SMSF deeds, however, it is difficult to remove a member without first obtaining the member’s written consent. Regulations 6.28 and 6.29 of the Superannuation Industry (Supervision) Regulations 1994 (Cth) (SISR) provide that a member’s benefit in a fund must not be rolled over or transferred from the fund unless that member has given the trustee the member’s written consent to the rollover. Therefore, unless the member provides prior written consent to being paid or rolled out, as appropriate, the SMSF trustee cannot simply “remove” the member’s entitlement from the fund. As you would be well aware, consent may be impossible to obtain where there has been a falling out, especially in the case of a divorce, separation or legal dispute. The key strategy that pre-emptively addresses this issue is conditional membership. Here, the existing member(s) with the larger account balance obtains the informed written consent before the new member is admitted in both their capacity as a member and trustee. Appropriate disclosure is made that the new member may be removed as both a member and trustee of the fund. Corporate trustees In the case of a corporate trustee, the person also needs to consent to their removal as a director. This requires the constitution to be examined to determine what is required to remove a director. Under the DBA Lawyers’ SMSF deed, the member(s) with the majority account balance can, if needed, remove a corporate trustee. However, typically the shareholders of a company can hire and fire the directors. Thus, those with the majority of voting shares already have this power. Therefore, the member(s) admitting a “conditional” member do not need to issue any shares in the company to such a new conditional member. This is the more efficient approach rather than having to replace the corporate trustee and go through all the paperwork of transferring assets, etc, to a new trustee company. Moreover, there is no legislative requirement for a member to have any shares in a company that acts as an SMSF trustee. Removing a member without a conditional membership strategy In the event the SMSF deed does not expressly provide for conditional membership, the member(s) may need to apply to the court (typically the Supreme Court) for intervention. Courts are generally reluctant to intervene in such situations unless the member has contravened the law, eg the drug addict son in the Triway case above who was a trustee and had access to the fund’s bank account. However the time, cost and inconvenience associated with legal action are likely to be very substantial. Thus, unless there is some substantive breach of the trustee or director duties committed by the member that needs to be removed, the court may not provide any practical solution. In these cases, there is the prospect of the SMSF being placed in a precarious position while the parties seek to resolve their differences. Typically, during these periods, the parties do not cooperate with each other to ensure the fund is compliant and often the tax and regulatory returns and other compliance matters are not attended to in a timely manner. This can result in numerous penalties and potentially non-compliance. While this can disadvantage all members, it impacts more on those with the greater account balance. Naturally, fairness dictates that the member(s) with the greater account balance should have greater say in the running of an SMSF. Conclusion An SMSF deed that allows for conditional membership, together with appropriate supplementary documentation including a company constitution, can provide members with greater peace of mind. Having a conditional membership strategy in place should minimise the opportunity for costly and uncertain disputes that will place the SMSF and its members at significant risk.

¶22-020 $1.6m balance cap examined — more tax on death benefits By Daniel Butler, Director, DBA Lawyers (May 2016) The proposed $1.6m balance cap will, if introduced, will result in substantial changes from 1 July 2017 and is likely to generate significantly more tax on the payment of death benefits. Summary of the new cap The Liberal Government’s balance cap announcement from the 2016 federal budget involves: • A maximum $1.6m (plus earnings thereon) balance cap on the total amount of superannuation an individual can claim tax-free as exempt current pension income (ECPI). • Earnings on the amount of balance cap will not be restricted by the $1.6m cap. Thus, if this amount increases in value by growth and net earnings during the retirement account phase, the total amount of the original balance cap plus the earnings remain tax-free. • Members already in the retirement phase with a balance above $1.6m will be required to reduce their retirement phase account balance to $1.6m by 1 July 2017. • Excess balances will generally be converted to accumulation phase. • A tax on amounts that are transferred in excess of the $1.6m cap (including earnings on these excess transferred amounts) will be applied, similar to the tax treatment that applies to excess nonconcessional contributions (NCC). • The amount of cap space remaining for a member seeking to make more than one transfer into a retirement phase account will be determined by apportionment. Naturally, the balance cap proposal depend s on a few hurdles to be successfully overcome before it is finalised as law for its mid-2017 introduction. Moreover, I have made numerous assumptions below on what I believe to be my best guess on how the new system will operate given the lack of information that has so far been published on this proposal. Thus, the speculation below should not be relied on but is my best guess on what may occur given my more than 30 years’ experience in the tax and superannuation industry. How will the balance cap work? Example of a couple who are over their balance cap We will start with an example of a Max and Jan who have the following facts: • They both have accumulated $2m each in their SMSF. • They both have attained 65 years and are currently both receiving account-based pensions. • They have no accumulation account. • The SMSF investments yield a 4% p.a. net return. As of 1 July 2017, both Max and Jan will have their balance caps set at $1.6m. They will both then have $400,000 in accumulation phase. The balance cap for each of Max and Jan has been fully utilised as to 100% of the $1.6m cap. The SMSF trustee will now pay tax in respect of Max and Jan’s accumulation accounts. The $1.6m plus earnings is exempt as this falls below each of their balance caps. However, earnings on the $400,000 for each of Max and Jan will be subject to tax, ie $800,000 × 4% = $32,000 × 15% = $4,800 tax (assuming there are no capital gains that qualify for the ⅓ CGT discount) or franking offsets. Since Max and Jan have used up their balance caps, they can no longer transfer any more to their retirement phase accounts.

Can a pension be paid from accumulation? The question that arises here is: can a pension be paid from accumulation mode? More particularly in Max and Jan’s case, assuming they each have a $2m account-based pension as at mid-2017, can $1.6m remain in the retirement phase account being the maximum of their balance cap and the remaining

$400,000 continue to fund their existing account-based pensions from their respective accumulation accounts? Traditionally, our mindset is that a pension is funded from a member’s pension account (not an accumulation account). From 1 July 2017, however, will the balance cap merely restrict the amount that can qualify for the ECPI or will it merely be the upper limit of any pension that can be funded? There is no reason theoretically to preclude a pension from being paid from two different accounts such as the retirement phase account and an accumulation account within the one superannuation fund. However, traditionally these accounts have been labelled as a pension account. The question therefore arises as to what approach the balance cap legislation will take. Let us now assume that the legislation specifies that the only account that can pay a pension is the retirement phase account which is restricted by each member’s balance cap. This would certainly ease the regulatory administration of the balance cap and the amount of ECPI that each member could obtain. This method would also give rise to significant flow on implications. Naturally, there are other methods that could be permitted such as allowing a pension to be paid from two accounts such as the retirement phase account and an accumulation account. However, the only account that benefits from the ECPI is the retirement phase account up to the balance cap limit. Thus, under either method, the assets that exceed the member’s balance cap are either paying a supplemental pension on top of the member’s retirement phase account (subject to their balance cap) or the member can simply withdraw further lump sum payments from their accumulation account as and when needed. My guess is that the legislation may restrict pensions from being paid from a retirement phase account that is limited by the balance cap. Any excess can be dealt with as lump sum withdrawals from accumulation phase. What happens on death? The balance cap will restrict the amount that will obtain the ECPI. Assets not covered by the balance cap will not obtain the benefit of the ECPI. Back to the example of Max and Jan where each has a $1.6m pension and a $400,000 accumulation interest. Typically, many couples prefer to revert their pension to their surviving spouse and this is exactly what Max and Jan intended to do. We will now assume Max dies first. However, Jan has already fully used her balance cap and therefore cannot obtain any further transfer to her balance cap. Thus, on Max’s death, it is unlikely under the new proposal that a surviving spouse will be entitled to obtain a reversionary pension where it exceeds the surviving spouse’s balance cap. This appears to be the outcome if the only pension that a member can obtain is via their retirement phase account subject to their balance cap. In the example above, Jan has fully utilised her balance cap. Thus, Max’s balance cap of $1.6m and his $400,000 accumulation benefit would have to be paid out to Jan as a lump sum death benefit. This will naturally result in significantly more tax being payable in respect of the assets that need to be realised to pay out Max’s benefit as a lump sum benefit as a result of his death. I expect that only the amount of $1.6m (plus net earnings thereon) balance cap would benefit from ECPI under reg 995-1.01(3) and (4) of the Income Tax Assessment Regulations 1997 (Cth) (ITAR) if Max did not have an automatically reversionary pension. Broadly, this regulation applies to extend the pension exemption (ie ECPI) until the assets supporting a pension are realised to pay out a death benefit where the pension is not an automatically reversionary pension. This regulation can minimise the tax and capital gains tax (CGT) arising to an SMSF trustee in respect of realising assets to pay out a deceased’s benefit on death. However, as discussed above the ECPI is subject to the balance cap and the amount in the accumulation account would not obtain this exemption. If an automatically reversionary pension could be payable, the pension exemption would usually continue. However, as discussed above, the new balance cap approach appears to preclude a surviving spouse receiving a reversionary pension where they already exceed their remaining balance cap. Thus, there is likely to be considerably more tax payable by a fund trustee in respect of the payment of

death benefits where the amount exceeds the deceased or surviving spouse’s balance cap. Succession planning will be more important under the new regime. Many have not yet envisaged that the substantially impact the balance cap proposal will have and should obtain expert advice in respect of what planning opportunities there are to minimise any resulting tax. Adding additional moneys to retirement phase account If Max and Jan had, say in 10 years down the track, further contributions to build up their superannuation balances they could make a further transfer to their retirement phase account. They should be in a position to add $200,000 as indexed to their then balance cap (ie in mid-2017 their balance cap was $1.6m and they had transferred only $1.4m towards their cap). Assuming the initial balance cap has been indexed to say $1.8m divided by $1.6m (ie $1.8/$1.6 = 1.125). Therefore, Max and Jan can each transfer a further $225,000 (ie $200,000 × 1.125) without exceeding their balance cap. Note, the balance cap is to be indexed by $100,000 increments in line with the consumer price index. What if a pension needs to be rolled back or rolled over to another fund? Taking the example above of Max and Jan who have pensions of $1.4m each and they divorce, then assuming Max has to roll his pension to another superannuation fund, there would need to be a mechanism to adjust his balance cap for the purposes of recognising the roll back to accumulation so Max’s interest could be rolled over to another superannuation fund. We would assume there would need to be a rule that allows the full amount to be rolled back into accumulation. Broadly, since the amount in the balance cap is capped, then on roll back the full amount should be within the balance cap even if there has been considerable earnings. However, where someone has already used up their balance cap, eg Max has used $1.4m of his $1.6m balance cap, then he has used 87.5% up of his balance cap. Thus, assuming Max’s balance cap amount had grown to $1.8m, then on roll back to accumulation the full amount of $1.8m should still be within his cap. Max would also have the ability to contribute 12.5% of his remaining balance cap of $200,000 (ie 12.5% of $1.6m). Thus, Max could contribute $2m on the basis the $1.8m was within his cap on roll back and his $200,000 remaining cap. What if you fully use up your balance cap The balance cap is a lifetime cap and in this regard, it allows no flexibility should a member who has already fully utilised their cap suffers a global financial crisis (GFC) event and loses around 50% of their retirement phase account. Similarly, if a member suffers a similar loss as a result of being embezzled by one of the many investment schemes or similar frauds they will have no further opportunity to obtain any ECPI in the future. Transfers that exceed the balance cap If Max and Jan transferred more than their remaining balance cap, the excess could be released after the ATO notified the members of the excess and provided a release authority. The amount of any associated earnings on the excess amount (calculated by reference to the general interest charge rate of around 10% p.a.) would be taxed at their respective marginal tax rates plus any applicable levies (Medicare and the Temporary Budget Repair Levy) if they elect to release the excess amounts. A 15% tax offset is then applied to Max and Jan’s tax to broadly reflect the tax payable by the fund. On the other hand, if Max and Jan decide not to release the excess amount, a 49% tax rate (equivalent to the excess non-concessional contribution tax) would apply to the amount of any excess transfer. Example of a couple who are under their balance cap If Max and Jan merely had $1.4m each in their pension accounts in their SMSF, then they would each be within their balance caps. They would have each used up 87.5% of their balance cap. There would be no need to change their plans and, subject to what else would need documenting, a trustee resolution confirming their balance caps are under the threshold as of 1 July 2017 would be prudent.

How and by when will we have to establish the balance cap? We will need to await the detail especially what might be required to appropriately document each

member’s balance cap. A period of 12 months was, for example, provided from mid-2007 for each superannuation provider to calculate the crystallised pre-July 83 amount in relation to each superannuation interest before a 30 June 2008 deadline to avoid a penalty of five penalty units for each member under s 288-105 of the Taxation Administration Act 1953 (Cth). We will also have to await by what time the balance cap needs to be established and completed as the accounting information and market values of assets are unlikely to be available as of 30 June 2017. In many cases, the accounts will not be finalised until close to 30 June 2018 and obtaining an appropriate market value can take considerable time. Conclusions Assuming the current Liberal-National Government is elected to office in July 2016, what the final rules that regulate the retirement phase account and balance cap will not be known for some time. Many will, however, start planning what they need to do leading up to 30 June 2017 as soon as detail about the new legislation starts being released. Many will need to focus on their estate and succession planning once the rules are clarified to ensure the impact of the new death tax is minimised. For related articles on the 2016 Federal Budget superannuation reforms refer to the following: www.dbalawyers.com.au/announcements/new-500000-lifetime-contribution-cap-retrospective-bad-law. www.dbalawyers.com.au/announcements/liberals-v-labor-different-election-outcomes-for-smsf-pensions.

¶22-025 Death benefit dependant — can an interdependency relationship exist between a deceased child and parent? By Gary Chau, Lawyer and Bryce Figot, Director, DBA Lawyers (August 2016) This article looks at whether a parent and deceased child can be in an interdependency relationship for the purpose of satisfying the definition of death benefit dependant in the Income Tax Assessment Act 1997 (Cth) (ITAA97). This article follows the Administrative Appeals Tribunal (AAT) decision in TBCL and Commissioner of Taxation (Taxation) [2016] AATA 264 (TBCL). The facts of TBCL were as follows: • On 5 June 2013, the son of Mr and Mrs TBCL was killed in a motorbike accident. At the time of his death he was 22 years old and was employed as a pilot. • Mr and Mrs TBCL became the administrators of their deceased son’s estate. • The son had lived with Mr and Mrs TBCL for all of his life except between 2007 and 2009 when he was studying interstate to become a pilot. • The superannuation scheme of the employer of the son included a life insurance policy. In May 2014, the insurer of the life insurance policy paid the sum in the amount of $500,000 to the son’s estate. • Mr and Mrs TBCL applied for a private binding ruling that the sum paid by the insurer was not assessable income because they were both death benefit dependants under s 302-60 of the ITAA97. Before this matter reached the AAT, the Commissioner ruled that Mr and Mrs TBCL were not death benefit dependants of their son since the information provided in Mr and Mrs TBCL’s ATO private binding ruling application did not satisfy the Commissioner that an interdependency relationship existed. The Commissioner’s ruling was subsequently upheld by the AAT. The AAT’s comments in this matter are interesting. The AAT did not rule out that Mr and Mrs TBCL were death benefit dependants, but rather, and similar to the Commissioner, determined that Mr and Mrs TBCL’s private binding ruling application did not have the requisite facts needed to satisfy the requirements in the ITAA97 that an interdependency relationship existed. At the conclusion of the decision, the AAT even went as far as to ask that the Commissioner request that Mr and Mrs TBCL make another private binding ruling application.

The AAT’s decision in this matter raises the importance of making sure an ATO private binding ruling application contains specific facts that directly address the requirements under the ITAA97. Additionally and more importantly, the AAT’s decision does not rule out the possibility that a parent can be a death benefit dependant of their deceased child. What is a death benefit dependant? The starting point is why would a parent of a deceased child want to be a death benefit dependant? The reason lies in s 302-60 of the ITAA97, which provides that a superannuation lump sum received as a result of the death of a person of whom the recipient is a death benefits dependant is not assessable income nor is it exempt income. This means that money paid out by the insurer in the case of TBCL would not be assessable income in the hands of the estate (and therefore indirectly his parents) if they were death benefit dependants. This leads to the question, who then can be a death benefit dependant? A death benefit dependant is defined under s 302-195(1) of the ITAA97, which provides: A death benefits dependant, of a person who has died, is: (a) the deceased person’s *spouse or former spouse; or (b) the deceased person’s *child, aged less than 18; or (c) any other person with whom the deceased person had an interdependency relationship under section 302-200 just before he or she died; or (d) any other person who was a dependant of the deceased person just before he or she died. If we look back at TBCL, the parents, for obvious reasons, would not be the spouse or the child of their son. For whether the deceased son satisfied s 302-195(1)(d) of the ITAA97, whether his parents were dependent on him, it is more likely that the deceased son was dependent on his parents and not the other way around. Hence, the only clear avenue for Mr and Mrs TBCL to be a death benefit dependant was whether they were in an interdependency relationship with their son. What is an interdependency relationship? The definition of “interdependency relationship” is found under s 302-200 of the ITAA97, which provides: (1) Two persons (whether or not related by family) have an interdependency relationship under this section if: (a) they have a close personal relationship; and (b) they live together; and (c) one or each of them provides the other with financial support; and (d) one or each of them provides the other with domestic support and personal care. Each of these requirements must be satisfied and importantly, must be true just before the death of the deceased person (see s 302-195(1)(c) of the ITAA97 above). To assist with determining whether there is an interdependency relationship, reg 302-200.01 of the Income Tax Assessment Regulations 1997 (Cth) (ITAR97) provides matters that should be taken into account in determining whether two people are in an interdependency relationship. It says: (1) For paragraph 302-200(3)(a) of the Act, this regulation sets out matters that are to be taken into account in determining whether 2 persons have an interdependency relationship. (2) The matters are: (a) all of the circumstances of the relationship between the persons, including (where relevant):

(i) the duration of the relationship; and (ii) whether or not a sexual relationship exists; and (iii) the ownership, use and acquisition of property; and (iv) the degree of mutual commitment to a shared life; and (v) the care and support of children; and (vi) the reputation and public aspects of the relationship; and (vii) the degree of emotional support; and (viii) the extent to which the relationship is one of mere convenience; and (ix) any evidence suggesting that the parties intend the relationship to be permanent; and (b) the existence of a statutory declaration signed by 1 of the persons to the effect that the person is, or (in the case of a statutory declaration made after the end of the relationship) was, in an interdependency relationship with the other person. In TBCL, the AAT looked at each of the above matters and found that the facts presented to the Commissioner were not indicative of interdependency relationship. In particular, the AAT considered whether Mr and Mrs TBCL’s intention to convert their garage into a private living space would be captured within the ambit of reg 302-200.01(2)(a)(iii) of the ITAR97. Unfortunately for Mr and Mrs TBCL, the AAT noted that the intention to convert the garage was not within the ambit of the regulations, but rather what is captured is the actual use of the property just before death. Furthermore, the requirement that the relationship was close personal relationship under s 302-200 of the ITAA97 was not satisfied since the AAT noted at paragraph 37 that: “[Mr and Mrs TBCL’s] reference to ‘love, care, affection and psychological assistance’ does not refer to any facts which provide a basis for any indication that there was such a relationship.” Of course, this requirement would be difficult to satisfy as most parent and child relationships would be of love, care and affection. But it should be borne in mind that when the interdependency provisions were drafted, they were drafted with same sex couples in mind. The then Prime Minister, the Hon John Howard MP explained in his Press Conference of 27 May 2004, that: “The change we’re announcing today will provide greater certainty for the payment of superannuation death benefits for those involved in interdependency relationships, including of course members of same sex relationships.” Further, the explanatory statement to the Income Tax Amendment Regulations 2005 (No. 7) (Cth) which inserted reg 8A to the then Income Tax Regulations 1936 (Cth), stated that: “Generally speaking, it is not expected that children will be in an interdependency relationship with their parents.” While the above does make clear where the legislative intent was, it does not rule out the possibility of an interdependency relationship between parent and child. Finally, the AAT’s comments in regards to domestic support and personal care are important as well. Both domestic and personal care, not one or the other, must have occurred just before death for s 302-200(1) (d) of the ITAA97 to be satisfied. Personal care is the harder test to satisfy since reg 302-200.02 of the ITAR97 requires that “1 or each of them provides the other with support and care of a type and quality normally provided in a close personal relationship, rather than by a mere friend or flatmate”. This is further elaborated by the examples provided in reg 302-200.02(2) of the ITAR97 which refer to “significant care” when a person is unwell or suffering emotionally. Of course, in TBCL, no facts were presented to suggest that either Mr or Mrs TBCL provided significant personal care to their son in the manner stipulated by the regulations or vice versa.

Can an interdependency relationship exist between adult child and their deceased parent? Yes. The requirements that need to be satisfied will still be the same. Conclusion This article has only covered one aspect of who can be a death benefit dependant under s 302-60 of the ITAA97. There are of course other relationships and facts that may assist in establishing an independency relationship between two people, including if one of those people had a disability. As always, you should seek the opinion of a legal practitioner who practices in SMSF law and can advise whether an interdependency relationship exists. This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.

¶22-030 Automatically reversionary pensions and super reform Contributed by Daniel Butler, Director and William Fettes, Lawyer, DBA Lawyers (August 2016) The $1.6m balance cap proposal adds another layer of complexity to understanding whether an automatically reversionary pension (ARP) is still an appropriate SMSF succession planning strategy. What is an ARP? We use the term ARP and deliberately avoid the term “reversionary pension” as a reversionary pension is generally a mere wish in relation to paying the pension to a nominated beneficiary. Under most SMSF deeds and pension documents, trustees retain a discretion to make a pension reversionary even though a member has nominated a reversionary beneficiary. Broadly, this has worked well over many years where a member separates from his or her spouse, as the last thing many deceased members would like happening is for their superannuation benefit to be paid to their former spouse. In contrast, an ARP is a pension that must be paid to the nominated beneficiary without any exercise of discretion by the fund trustee. Special wording in an SMSF deed and pension documentation is required to ensure a pension is an ARP as discussed below. This is to abide by the ATO’s view in Taxation Ruling TR 2013/5 where the Commissioner states at [29]: “A superannuation income stream ceases as soon as a member in receipt of the superannuation income stream dies, unless a dependant beneficiary of the deceased member is automatically entitled, under the governing rules of the superannuation fund or the rules of the superannuation income stream, to receive an income stream on the death of the member. If a dependant beneficiary of the deceased member is automatically entitled to receive the income stream upon the member’s death, the superannuation income stream continues.” Moreover, the ATO elaborates on what constitutes “automatic” for tax law purposes in TR 2013/5 at [126]: “A superannuation income stream automatically transfers to a dependant beneficiary on the death of a member if the governing rules of the superannuation fund, or other rules governing the superannuation income stream, specify that this will occur. The rules must specify both the person to whom the benefit will become payable and that it will be paid in the form of a superannuation income stream. The rules may also specify a class of person (for example, spouse) to whom the benefit will become payable. It is not sufficient that a superannuation income stream becomes payable to a beneficiary of a deceased member only because of a discretion (or power) granted to the trustee by the governing rules of the superannuation fund. The discretion (or power) may relate to determining either who will receive the deceased member’s benefits, or the form in which the benefits will be payable.” Accordingly, if there is any discretion afforded to the fund trustee under the governing rules of the fund or the pension documentation in regard to paying a particular superannuation dependant or the payment method, the ATO will consider the pension ceases on death for tax law purposes. This can have important consequences for SMSF succession planning, including insurance payouts and the retention of other valuable concessions. We turn now to consider some key areas where having an ARP in place can provide some advantages.

Insurance For those SMSF members who do hold a life insurance policy in their SMSF, an ARP may be worthwhile if the following conditions are satisfied: • the SMSF member is likely to receive a sizeable insurance payout upon their death or permanent incapacity • the relevant insurance policy premium is paid from the member’s pension account, and • the relevant pension account that serviced the insurance premiums is comprised of a high proportion of tax free component. Broadly, in these circumstances, when a life insurance payment is allocated to a member’s pension account, the payment will broadly take on the same proportion of the underlying taxable and tax free components as the member’s pension.

Example If a deceased member commenced a pension entirely comprising tax free component, and the insurance premiums were deducted from that member’s pension account, then the $1m insurance proceeds paid to the SMSF on that member’s death and allocated to the deceased member’s pension account would constitute a 100% tax free component. This could fund a tax-free reversionary pension.

In contrast, if a deceased member’s pension ceased on death, any insurance proceeds that are subsequently paid into the fund would form part of member’s accumulation account and comprise a 100% taxable component. Grandfathering of favourable income testing Another area where ARPs may prove important is for the retention of concessions that relate to income testing. For instance, the eligibility testing for the age pension provided by Centrelink or the Department of Veteran Affairs (DVA) includes a more favourable income test for account-based pensions (ABP) in place prior to 1 January 2015. For ABPs that commenced prior to 1 January 2015, only the amount of pension withdrawn less a deductible amount (broadly, the deductible amount is the amount of the member’s pension account divided by their life expectancy) counts towards the income test. However, for ABPs commenced from 1 January 2015, the amount of the member’s pension account for an ABP is deemed to earn income at prescribed rates for the purposes of the income test (even though the member’s account balance has suffered a loss). Where an ARP was in place prior to 1 January 2015, and thus the pension continues on the member’s death, the more favourable income testing regime for ABPs commenced is grandfathered for the reversionary pensioner. Eligibility for the Commonwealth Seniors Health Card (CSHC), which allows access to cheaper prescriptions via the pharmaceutical benefits scheme and provides certain other government funded medical services, may also be affected. Before 1 January 2015, ABPs were not assessed for CSHC eligibility. However, since 1 January 2015, earnings on the assets supporting ABPs are assessed under the adjusted taxable income test. The income from the ABP will also be taken to have a deemed rate of return. Having an ARP in place enables a reversionary pensioner to preserve the potentially favourable “grandfathered” status for Centrelink, DVA and CSHC income testing in respect of ABPs that commenced prior to 1 January 2015. This allows, for instance, a surviving spouse to continue to be paid a pension following the death of their spouse, and therefore, continue the favourable income treatment of a pre2015 ABP.

$1.6m balance cap The $1.6m balance cap proposal included in the May 2016 Federal Budget will limit the amount that a member can hold in retirement or pension phase from 1 July 2017. This will limit or cap the amount that obtains the exempt current pension income (ECPI) exemption from tax in a fund. Broadly, from 1 July 2017 only earnings on assets capped at $1.6m that support the fund’s liability to pay a pension will be taxfree. The balance cap proposal also allows earnings on the $1.6m to obtain the ECPI exemption as there are no restrictions proposed to be placed on subsequent earnings on the $1.6m balance cap amount, which will be allowed to be maintained in the fund. While the draft legislation for the balance cap proposal has yet to be released (there may also be a chance that the start date of 1 July 2017 gets deferred to allow for the systems to be implemented to cater for the wide spread changes relating to this measure), it does appear that this proposal will significantly impact SMSF succession planning. This is because a death benefit pension (ie an ARP on the death of a spouse) paid to a surviving spouse who has already utilised their $1.6m balance cap will likely result in additional tax payable. Additional tax is likely to arise through a requirement that the death benefit be paid as a lump sum on the spouse’s death as the surviving spouse already has used up their balance cap. Alternatively, assuming the pension can revert under the proposal, then since the surviving spouse has already used up their balance cap, any further amount added to their member balance in superannuation could be subject to substantial tax. The $1.6m balance cap has an excess balance transfer tax that applies when someone seeks to transfer an amount in excess of their balance cap to their retirement account. This tax is equivalent to 49% of the excess amount. If an ARP locks in a reversion, subject to what the finalised law provides, and an excess pension phase transfer occurs above the balance cap then the excess will be subject to penalty tax of 49%. Naturally, this would have a severe impact on SMSF succession planning for many couples. If, however, there is no flexibility provided under the proposed legislation in reverting to a spouse who has already used up their balance cap, then this may result in a compulsory cashing event for the deceased spouse requiring a lump sum payment to be made. Since the ECPI will only cover tax on assets up to a maximum of $1.6m (plus earnings thereon as indexed), then the other assets that need to be liquidated or disposed of may give rise to taxable gains on which tax is payable. Over time, considerable extra revenue is likely to be raised through this measure by the ATO. Accordingly, members in retirement phase with pension account balances exceeding $1.6m can no longer rely on ECPI applying to any death benefit pensions paid to them as a surviving spouse or eligible beneficiary. There is likely to be detailed discussion and, hopefully some meaningful consultation, in relation to these concerns before the legislation is finalised. Therefore, the $1.6m balance cap represents a new hidden death tax and it poses a challenge for ARPs as a tax effective SMSF succession planning tool. However, many people will still probably want to position themselves with an ARP until the uncertainty of how the $1.6m balance cap measure is resolved. If the ARP results in the surviving spouse’s balance cap being exceeded further planning at or before that time may be needed. Reduced flexibility in relation to in specie transfers There can also be disadvantages in having an ARP. Having an ARP in place may, for instance, reduce the flexibility in relation to an in specie payment of superannuation death benefits. The extension of the pension exemption on death for non-ARPs under reg 995-1.01(3) and (4) of the Income Tax Assessment Regulations 1997 (Cth) provides greater flexibility in relation to payment of assets supporting a pension to a fund member. Broadly, these provisions enable a lump sum death benefit to be paid by way of an in specie transfer of assets and be treated as an income stream payment covered by ECPI subject to the balance cap limit from 1 July 2017. Note that these regulations do not apply to an ARP. To pay a lump sum by way of an in specie transfer of an asset in the context of an ARP, the ARP must be partially commuted, which can create complications for claiming ECPI (subject also to the balance cap proposal).

SMSF and pension documentation The above strategies depend on quality SMSF, pension and other documentation. Many SMSF deeds and pension documents may not provide an adequate foundation to implement an ARP consistent with the ATO’s view in TR 2013/5. Accordingly, advisers should ensure that their clients have appropriate documentation in place to implement their clients’ SMSF succession plans, including a strategic SMSF deed supported also by appropriate pension and BDBN documentation. Naturally, DBA Lawyers’ SMSF deed and related documents provide for and support smooth and taxeffective SMSF succession planning outcomes. Conclusion As can be seen from the above, ARPs are not a “one-size-fits-all” solution for every situation, but they do have a strategic role to play in tax-effective SMSF succession planning. Advisers should be aware of the benefits and challenges of utilising ARPs, including in the context of insurance, government concessions, and the proposed $1.6m balance cap.

¶22-035 The $1.6m transfer balance cap explained By William Fettes, Lawyer, Bryce Figot, Director and Daniel Butler, Director, DBA Lawyers (October 2016) On the 27th September 2016, the Department of Treasury released the federal government’s proposed superannuation reforms. These materials provide long-awaited detail on the workings of the $1.6m transfer balance cap measure. This article explains some key take-away points about this measure. The transfer balance cap and transfer balance account Broadly, the $1.6m balance cap measure is a limit imposed on the total amount that a member can transfer into a tax-free pension phase account from 1 July 2017. The general transfer balance cap is $1.6m for the 2017/18 financial year subject to indexation (see below for further information on the indexation rules). An individual’s personal transfer balance cap is linked to the general transfer balance cap. All fund members who are in receipt of a pension on 1 July 2017 will have a personal balance cap of $1.6m established at that time. Otherwise, a fund member’s personal balance cap comes into existence when they first become entitled to a pension. An individual’s personal transfer balance cap is equal to the general balance cap for the relevant financial year in which their personal balance cap commenced. Usage of personal cap space will be determined by the total value of superannuation assets supporting existing pension liabilities for a member on 1 July 2017, as well as the capital value of any pensions commenced or received by a member from 1 July 2017 onwards. A member’s available cap capacity over time is subject to a system of debits and credits recorded in a “transfer balance account”, which is a kind of ledger whereby amounts transferred into pension phase are credited to the account and amounts commuted or rolled-over are debited from the account. Earnings and capital growth on assets supporting pension liabilities are ignored when applying the personal transfer balance cap. Thus, a member’s personal balance cap may grow beyond the $1.6m cap due to earnings and growth without resulting in an excess. As such, a taxpayer who allocates growth or higher yielding assets to their balance cap will generally be better off if their pension assets appreciate in value. However, note the limitations with regards to the segregation method discussed below. Any amounts in excess of a member’s personal transfer balance cap can continue to be maintained in their accumulation account in the superannuation system. Thus, members with superannuation account balances greater than $1.6m can maintain up to $1.6m in pension phase and retain any additional balance in accumulation phase. What counts as a credit?

The following items count as a credit towards an individual’s transfer balance account and thereby their personal transfer balance cap: • the value of all assets supporting pension liabilities in respect of a member on 30 June 2017 • the capital value of new pensions commenced from 1 July 2017 • the capital value of reversionary pensions at the time the individual becomes entitled to them (subject to modified balance cap rules for reversionary pensions to children), and • notional earnings that accrue on excess transfer balance amounts. As can be seen from the above list, death benefit pensions count towards to the recipient’s personal transfer balance cap. The inclusion of death benefit pensions as part of the reversionary beneficiary’s transfer balance cap is in accordance with DBA Lawyers’ prediction in our 1 August 2016 newsfeed article. This aspect will have a significant impact on the succession plans of all fund members who collectively with their spouse have more than $1.6m in superannuation. Fortunately, there is an important concession. An excess will only occur as a result of a death benefit pension six months from the date that the reversionary beneficiary becomes entitled to receive the pension. This means there is a grace period for reversionary beneficiaries to commute their pension interest(s) to stay within their personal transfer balance cap without triggering any excess. The exposure draft explanatory memorandum (“EM”) explains the six-month period as follows: “This gives the new beneficiary sufficient time to adjust their affairs following the death of a relative before any consequences — for example, a breach of their transfer balance cap — arise.” Typically, a surviving spouse suffers years of grieving following the loss of a spouse but only has a sixmonth period to make a decision on a reversionary pension if that results in an excess of their personal transfer balance cap. What counts as a debit? A member’s transfer balance account is debited when they commute (partially or fully) the capital of a pension. When a commutation occurs, the debit entry to the transfer balance account is equal to the amount commuted. Accordingly, it is possible for an individual’s transfer balance account to have a negative balance if their debits exceed their credits. For example, a full commutation of a pension where the assets supporting that pension have grown from $1.6m to $1.7m will result in a transfer balance account of negative $100,000. Ordinary pension payments do not count as debit entries for the purposes of the transfer balance account. Proposed legislative amendments will ensure that partial commutations do not count towards prescribed minimum pension payments. This proposal may also impact a member with an account-based pension electing to convert an amount to a lump sum for claiming their low rate cap. In addition to the above recognised debits, relief will be available in relation to certain events where an individual loses some or all of the value of assets that are held in pension phase. The proposed relief concerns family law payment splits, fraud and void transactions under the Bankruptcy Act 1966 (Cth). In these circumstances, an individual will be able to apply to the ATO for relief so that their transfer balance account can be debited to restore their personal transfer balance cap, eg if a member is defrauded of their super savings and the perpetrator is convicted, then a debit (or restoration) can be made to their transfer balance account. At this stage, there is no relief proposed in relation to a major economic downturn eroding the value of fund assets held in pension phase. Therefore, if another global financial crisis were to occur, any adverse economic effects on the assets supporting pensions could substantially impair a member’s personal transfer balance cap. Excess personal transfer balance cap Individuals who exceed their personal transfer balance cap will have their superannuation income

streams commuted (in full or in part) back into accumulation phase and notional earnings (see below) on the excess will be subject to an excess transfer balance tax. Notional earnings accrue on excess transfer balances based on the general interest charge. Notional earnings accrue daily until the breach is rectified and are generally credited towards an individual’s transfer balance account (subject to a transfer balance determination being made by the Commissioner). The draft EM provides the following example of an excess transfer balance (refer to example 1.14): “On 1 July 2017, Rebecca commences a superannuation income stream of $1m from the superannuation fund her employer contributed to (Master Superannuation Fund). On 1 October 2017, Rebecca also commences a $1m superannuation income stream in her SMSF, Bec’s Super Fund. On 1 July 2017, Rebecca’s transfer balance account is $1m. On 1 October 2017, Rebecca’s transfer balance is credited with a further $1m bringing her transfer balance account to $2m. This means that Rebecca has an excess transfer balance of $400,000. On 15 October 2017, the Commissioner issues an excess transfer balance determination to Rebecca setting out a crystallised reduction amount of $401,414 (excess of $400,000 plus 14 days of notional earnings). Included with the determination is a default commutation authority which lets Rebecca know that if she does not make an election within 60 days of the determination date the Commissioner will issue a commutation authority to Bec’s Super Fund requiring the trustee to commute her $1m superannuation income stream by $401,414.” As can be seen from the above example, there is some flexibility built into the system for proactive rectification where an excess transfer balance occurs. An excess transfer balance tax is payable on the accrued notional earnings of the excess amount to neutralise any benefit received from having excess capital in the tax-free retirement phase. The excess transfer balance tax is assessed for the financial year in which a member breaches their transfer balance cap. The excess transfer balance tax is 15% on notional earnings for the first breach and 30% for second and subsequent breaches. Indexation of the balance cap The transfer balance cap is indexed in increments of $100,000 on an annual basis in line with the Consumer Price Index. A person’s eligibility to receive indexation increases in relation to their personal transfer balance cap is subject to a proportioning formula based on the highest balance of the member’s transfer balance account compared to the member’s personal balance cap. The proportioning formula as applied to an example increase of $100,000 is as follows: (Personal transfer balance cap − highest transfer balance) Personal transfer balance cap

× $100,000

An example of how the proportioning formula applies in practice is set out below.

Example John commences a pension with an account balance of $800,000 in financial year 2017/18. At that time, he has used 50% of his $1.6m personal transfer balance cap. If the general transfer balance cap is indexed to $1.7m in 2019/20, John’s personal transfer balance cap is increased by $50,000 because he is only eligible to take 50% of the $100,000 increase. Accordingly, John can now commence a pension with capital of $850,000 without breaching his personal transfer balance cap. The above answer does not change if John partially commutes his pension prior to the indexation increase, as the formula is based on John’s highest transfer balance (ie $800,000).

A member who has exhausted or exceeded their personal transfer balance cap will not be eligible for any cap indexation. CGT relief

The draft legislation also provides CGT relief which broadly enables the cost base of assets reallocated from pension to accumulation phase to be refreshed to comply with the transfer balance cap or the new transition to retirement income stream arrangements. The draft EM states: “Complying superannuation funds will now be able to reset the cost base of assets that are reallocated from the retirement phase to the accumulation phase prior to 1 July 2017. Where these assets are already partially supporting accounts in the accumulation phase, tax will be paid on this proportion of the capital gain made to 1 July 2017. This tax may be deferred until the asset is sold, for up to 10 years.” Segregated assets Broadly, an SMSF trustee can elect to obtain CGT relief to reset the cost base of a segregated asset to its market value provided the asset ceases to be a segregated asset prior to 1 July 2017. The market value is determined “just before” the time the asset ceased being a segregated current pension asset. Typically, an asset would cease to be segregated by being transferred from pension to accumulation phase. However, it appears that an asset could also cease being segregated by being treated as an unsegregated asset (with an associated actuarial report). It is important to note, however, that the segregation method will not be available to SMSFs and small APRA funds, with at least one member in pension mode who has a total superannuation fund balance of over $1.6m (in all funds). This limits planning opportunities that may otherwise be available to SMSFs under the segregation method. Unsegregated or proportionate assets Broadly, where an asset is supporting a pension liability using the unsegregated or proportionate method, an SMSF trustee can elect to obtain CGT relief to reset the cost base of an asset to its market value on 1 July 2017 subject to the following requirements: • the fund must calculate a notional gain on the proportion of the asset that is effectively attributable to the accumulation phase as at 30 June 2017 • if not deferred, the fund must add this notional gain to its net capital gain (or loss) for financial year 2017 which effectively crystallises the tax liability that would have arisen if that asset had been sold in financial year 2017 • however, an SMSF trustee can elect to defer the notional gain for up to 10 years (ie up to 1 July 2027) unless a realisation event occurs earlier than 1 July 2027, and • if a realisation event does not occur by 1 July 2027, the cost base of the relevant asset will revert to its original cost base. If the relevant asset is sold before 1 July 2027, the deferred notional gain is added to any further net capital gain (or adjusted against any net capital loss) made on a realisation event such as the ultimate sale of that asset. This further notional gain is calculated based on the higher cost base determined as at 30 June 2017 (being the market value of that asset at 30 June 2017 with any further adjustments to that asset’s cost base since 30 June 2017). Thus, an SMSF trustee may elect to reset the cost base of an asset. This election may be applied on an asset-by-asset basis as some may prefer not to reset the cost base of all eligible assets to market value, eg a particular asset’s market value may be lower than its cost base and a cost base reset in that context could result in a greater future capital gain. Further, this election can be made in the SMSF’s financial year 2017 annual return and does not need to be made prior to 1 July 2017 (as is the case for a CGT reset for a segregated asset as discussed above). The net capital gain attributable to the accumulation interest that is not exempt under the exempt current pension income provisions is taxed at 15% subject to the 1/3 CGT discount available for assets held for more than 12 months. Refer to examples 1.45, 1.46 and 1.47 in the draft EM. Although the prospect of resetting the cost base of current pension assets may be attractive in the lead up

to 1 July 2017, paragraph 1.226 of the draft EM reminds SMSF trustees not to overlook the general antiavoidance provisions in Pt IVA of ITAA 1936. This paragraph of the EM states: “The CGT relief arrangements are only intended to support movements of assets and balances necessary to support the transfer balance cap and changes to the TRIS. It would be otherwise inappropriate for a fund to wash assets to obtain CGT relief or to use the relief to reduce the income tax payable on existing assets supporting the accumulation phase. Schemes designed to maximise an entity’s CGT relief or to minimise the CGT gains of existing assets in accumulation phase may be subject to the general anti-avoidance rules in Part IVA.” Naturally, the impact of the CGT reset provisions will need to be carefully considered as there are numerous strategies that will unfold under the draft proposals. Conclusions The proposed $1.6m transfer balance cap measure involves substantial changes to Australia’s superannuation system, especially the tracking of each member’s personal balance cap. The balance cap proposal will reduce the tax effectiveness of pensions due to the new cap and have a major impact on succession planning strategies giving rise to substantially more tax payable overall in respect of death. In particular, many couples will not like the fact that their deceased spouse’s reversionary pension gets “retested” to a surviving spouse where the surviving spouse is subject to only their own $1.6m personal balance cap. The government has seen that raising extra tax revenue is preferred rather than allowing a deceased spouse’s pension that would have already been tested within their personal transfer balance cap to revert to a surviving spouse. We see this as a major issue that is likely to arise in submissions. Note that the above commentary is a general summary only based on exposure draft legislation and explanatory material that is subject to change. For full details, see consult.treasury.gov.au/retirement-income-policy-division/super-reform-packagetranche-2.

¶22-040 Changes for superannuation funds — the end of TRIS? By Ben Miller, Tax Writer, CCH (October 2016) The government recently released the second tranche of exposure draft legislation and explanatory material relating to the implementation of proposed superannuation reforms. The draft legislation includes a proposed change to the tax exemption on earnings inside superannuation funds for some types of income streams. The current law and why is it changing? The core principle underpinning the superannuation system in Australia is for individuals to provide themselves with an income stream for retirement. With the implementation of the Simpler Super regulations in 2007, an exemption for income tax has been available for superannuation interests that provide an income stream during the year. To determine the amount of income that is exempt from tax for a given year, a superannuation fund is able to segregate its assets between pension (income stream) assets and accumulation assets. Alternatively, the fund may use an actuary to calculate the proportion of the income tax exemption on earnings in pension phase. The current rules allow a superannuation fund member to access their benefits, via a lump sum or income stream, if they meet a condition of release. One particular condition of release, attaining preservation age, allowed a member to partially access their benefits before retirement and also attain an exemption from income tax. The original intention of a transition to retirement income stream (TRIS) was to assist individuals who were nearing retirement and would work less hours as a result. A supplementary income is available from their superannuation fund complemented by tax-free earnings. The income stream itself may also be taxfree to the individual. However, the actual implementation of the law over the past ten years has seen a TRIS used as a tax minimisation strategy. Many taxpayers have continued with similar working commitments despite declaring a “transition” phase of their working life.

The proposed law introduces the concept of “retirement phase” into Div 307 of ITAA 1997, which covers all conditions of release except transition to retirement income streams. Only a retirement phase income stream would get the income tax exemption on earnings. Will this new legislation be the end of TRIS? Due to the concessional treatment of tax on superannuation benefits, an individual could save thousands of dollars in tax by commencing a TRIS, salary sacrificing to superannuation and continuing to work as per normal conditions. The proposed legislation would see a significant reduction in those tax advantages, but an advantage would still exist. A detailed example of the proposed rules and their analysis against the current rules are displayed below. Example Alice is 58 years of age as at 1 July 2016 and has attained preservation age, but may not have met a condition of release. She is still working full time, earning a salary package of $90,000 per annum. Her slightly above average earnings is also reflected in a modest superannuation balance of $340,000 (all taxable component). By continuing as per usual, she would receive deposits of $62,116 for the year, after taking out PAYG withholding and superannuation guarantee at 9.5%. If her superannuation balance returned 6% on investment, her member’s statement would also show an increase of $23,977 after the contributions were added and tax subtracted. Under the current laws, she could commence a TRIS by salary sacrificing to the concessional cap of $25,000 and still receive the same net salary after withholding. However, overall she would pay $3,471.32 less in taxes between herself and the fund. Also her superannuation balance would be better off by approximately $3,000. The calculations are below:

No TRIS

TRIS (2016/17)

Salary (1)

82,192

65,000

Employer superannuation (2)

7,808

25,000

Salary package

90,000

90,000

PAYG withheld

(20,076)

(14,040)

Pension received (3)

-

14,500

PAYG withheld

-

(3,276)

62,116

62,184

82,192

79,500

20,001.88

18,974.50

-

(2,175.00)

20,001.88

16,799.50

Contributions

7,808

25,000

Earnings

20,400

20,400

-

(18,985)

28,208

26,415

Tax expense (15%)

4,231.20

3,926.26

Overall tax expense

24,233.08

20,761.76

Net salary (including superannuation)

Individual tax rates Taxable income (1+3) Tax expense (incl. levies) Less: Tax offsets (15% of pension) Tax payable

Superannuation fund

Less: ECPI Taxable income

Note: In the example, Alice takes our slightly more than the minimum (4%) of superannuation in order to collect the same “takehome” money. With the proposed change in legislation, however, the superannuation fund would be unable to claim an amount as exempt current pension income (ECPI). The taxable income of the fund would be $45,400 and have a tax expense of $6,810. Overall, Alice will still be in a better position by commencing a TRIS with the new legislation. Compared to taking no TRIS, she would pay $623.08 less in taxes across all entities and her superannuation balance would increase by approximately $110.

No change to individual taxation Throughout the entire process, from the Budget announcement to draft Bill and explanatory memorandum, the government has made no indication that there will be a change to the way income streams are taxed at the individual level. This means that once a self-funded retiree reaches the age of 60, the income stream they draw from superannuation accounts will continue to be non-assessable nonexempt income. If Alice was over 60 years of age in the example above, the pension would be non-assessable nonexempt income, meaning the tax payable on her taxable income would be reduced to $13,972.00. As there are no proposed changes to individual taxation, Alice would still better off by $3,451.08 in all taxes when salary sacrificing to superannuation at the same time as receiving a transition to retirement income stream. Also, she would receive an additional $2,444.00 in net salary and the super balance will increase by $1,013.20. Conclusion Across the board, using salary sacrifice (or the proposed extension of deductible personal superannuation contributions) would continue to provide a tax benefit for individuals who are in receipt of a nonassessable non-exempt pension income. The only taxpayers who would be worse off under the proposed legislation are individuals who take out a TRIS but who are already liable to pay Division 293 tax for adjusted taxable incomes above $250,000 in an income year. For these taxpayers, however, there would be very little opportunity for salary sacrificing up to the concessional contribution limit of $25,000 after superannuation guarantee is taken into account. From the above examples, the proposed legislation will leave an individual under the age of 60 better off by $733 and an individual over the age of 60 would be better off by $6,908. Included in the draft explanatory memorandum is a proposal to remove superannuation lump sums as counting towards the minimum draw-down requirements for account-based income streams. Even though there is to be further consultation in relation to these amendments, it is assumed that this will apply to the above. As a result, an individual taking a superannuation lump sum payment will not be able to reduce their taxable income in a TRIS by use of the superannuation low rate cap (which is currently $195,000).

¶22-045 The new NCC rules and the new AFSL regime: a delicate balancing act By Philippa Briglia, Lawyer, DBA Lawyers and Bryce Figot, Director, DBA Lawyers (November 2016) Introduction The government recently released for public consultation the third round of exposure draft legislation and explanatory material to lower the annual non-concessional contributions (“NCCs”) cap to $100,000 and restrict eligibility to make NCCs to individuals with superannuation balances below $1.6m from 1 July 2017. While this legislation is in exposure draft form only (and has not yet been introduced in parliament as a Bill) it is important for advisers and those hoping to get some more money into super by way of NCCs to become familiar with the latest proposals. If the latest proposals get finalised as law, they may be effective from 1 July 2017, leaving a small window of opportunity for people to act. Perhaps the most time sensitive change is the lowering of the annual NCC cap to $100,000 (down from $180,000) for FY2017 and the corresponding reduction in the amount allowed to be contributed under the

three-year bring forward rule (the current amount is $540,000 — this is to be lowered to $300,000 from 1 July 2017 subject to transitional rules). The other key change is the requirement that an individual must have a total superannuation balance (“TSB”) immediately before the start of each financial year (“FY”) of less than the general transfer balance cap (for a discussion on the transfer balance cap please see this article) which is $1.6m for FY2018 — to be indexed in increments of $100,000 — to be eligible to make further NCCs. From 1 July 2017, if a member has a TSB of more than $1.6m on the prior 30 June, they will be precluded from making further NCCs. The practical implication of this, simply put, is that a lot of people may want to make contributions prior to 1 July 2017. However, the complexity of the new proposals means that expert advice and, in particular, appropriate advice — bearing in mind the Australian financial services licence (“AFSL”) rules — needs to be provided. How it will work The importance of timing is probably best illustrated by a practical example. First, let’s compare the current position with the proposed changes. Under the current law, we have an annual NCCs cap of $180,000. Under the current bring forward rule, the total NCCs cap for the current FY and the next two FYs of $540,000, provided that: • NCCs in that first FY exceeded $180,000 • the member did not trigger the bring forward rule in any of the two prior FYs, and • the member is under age 65 at any time during the first FY. However, the following changes are proposed from 1 July 2017: • the three-year bring forward rule is retained but the annual $180,000 NCCs cap is to be reduced to an annual $100,000 NCCs cap. • individuals with total super balances of greater than $1.6m on each prior 30 June are unable to make NCCs in the next FY. • transitional rules apply, meaning that if an individual has triggered the bring forward rule and has not fully used their NCCs bring forward amount before 1 July 2017, the remaining bring forward amount will be reduced on 1 July 2017 to reflect the new annual caps. So, how does this work in practice? Take Jane. Jane is under 65, and has not triggered the bring forward rule in FY2015 or FY2016. She had $100,000 in super on 1 July 2016, and made an NCC of $200,000 on 25 October 2016. She now wants to (and is in a position to do so) make further NCCs. If Jane makes another NCC before 1 July 2017, she can contribute a further $340,000 (as she gets the benefit of the full $540,000 bring forward cap). But if Jane waits until 1 July 2017 to make a further NCC, the maximum amount she can contribute is a further $180,000. Why? Because as Jane did not fully use her NCC bring forward amount before 1 July 2017, the remaining bring forward amount is reduced on 1 July 2017 to reflect the new caps. The bring forward cap on 1 July 2017 is $380,000, so $380,000 − $200,000 (her NCC made on 16 September 2016) = $180,000. What if Jane triggered the bring forward rule in FY2016? Let’s say that Jane makes an NCC of $200,000 in FY2016. If she waits until 1 July 2017 to make another NCC, the transitional cap of $460,000 will apply. That means that Jane can only contribute a further $260,000 ($460,000 − $200,000). You can see how the timing can result in NCCs of $540,000 versus NCCs of $460,000 or $380,000 depending on whether Jane invoked her bring forward rule in FY2016 or FY2017. What a difference a day or a year can make!

How to convey this information to clients You can see from the above figures that many clients will appreciate being contacted by their advisers to give them a heads-up about this limited window of opportunity, and some clients will almost certainly want to make contributions prior to 1 July 2017. But in light of the new AFSL regime, advisers will have to be careful in terms of how they convey this information to clients. It’s really important that advisers make themselves familiar with the relevant provisions of the Corporations Act 2001 (Cth) and the Corporations Regulations 2001 (Cth) relating to financial services and financial product advice. Broadly, if you make a recommendation or provide an opinion that is intended to influence a person in relation to a financial product, or could reasonably be regarded as being intended to have such an influence, then you are providing financial product advice. An SMSF is considered a financial product under these rules. So how can you keep clients updated on the proposed superannuation reforms if you don’t hold an AFSL, or you hold an AFSL but don’t want to provide a Statement of Advice? Remember that you don’t need to be within the AFSL regime if you provide factual advice only. Factual advice, according to ASIC, is objective and factual information that is not intended to influence a person’s decision on a financial product. For example, providing a client with a government factsheet on the superannuation reforms (you can find a list of these on the budget website) would be factual advice. But what if a client presses you for further information, like “ok, I’ve read the factsheet, but what do the new NCC rules mean for me?” ASIC RG 244 contains a template for dealing with these sorts of questions, with a handy introduction: “I can give you some factual information about making extra contributions to your superannuation this financial year, but I’m unable to provide you with any advice about contributing to your superannuation fund. If you would like personal advice about contributing to superannuation, I can set up a meeting for you with someone from our financial advice team. [Naturally, this wording could be varied to suit the circumstances as many accountants will need to refer such matters to an adviser who has an AFSL.]” Providing this factual information may then equip the client to make a decision on their own, and the client might then instruct you to assist them to facilitate the contribution to super. If this is indeed execution only (ie the client has already made up their mind, and simply wants you to make it happen), then an AFSL is not required, but remember to be aware of the necessary disclaimers. If you’re unsure of what should be included in the disclaimer, the DBA Lawyers non-licensed (AFSL) SMSF Advisers Kit contains templates of various execution only services, including a range of disclaimers that can be used. Alternatively, the client may press you for a recommendation tailored to their personal circumstances. Making such a recommendation would fall within the AFSL regime and would therefore need to be handled by an appropriately licensed adviser.

¶22-050 Why successor directors are better than alternate directors for SMSF succession planning By Gary Chau, Lawyer and Bryce Figot, Director, DBA Lawyers (November 2016) This article will address the problems that can arise in using alternate directors in an SMSF succession planning context and suggest a possible solution. As with all succession planning discussions, SMSF succession planning being no different, people want to ensure the right people are in control when they die or lose capacity. For this to happen, generally the right mechanisms and structures must be in place well before the person dies or loses capacity. Without the right mechanisms, the wrong people may come into control, and these people may not carry out the person’s wishes or even know how to ensure the person’s wishes are to be carried out. The solution can be to appoint a successor director. There is a train of thought that an alternate director may be the solution, but in reality, an alternate

director has limited usefulness in succession planning. What is the difference between an alternate director and a successor director? An alternate director usually indicates the appointment of a temporary director who acts as an alternate to exercise some or all of the appointing director’s powers for a specified period. This appointment usually requires the consent of the other directors. On the other hand, a successor director is a special company mechanism whereby a director appoints one or more other people who actually step in as fully fledged directors when the first director loses capacity or dies. Special rules in the company constitution are needed to implement successor directors. Alternate directors In succession planning, a director may desire that a certain person that they trust “steps into their shoes” when they die or lose capacity. What should this director do to ensure their wishes are put in place? Let’s look at some different scenarios where alternate or successor directors are in place. Scenario A John and Sarah are directors of their SMSF’s corporate trustee with one share each. John and Sarah are also the only two members of their SMSF. Alex is the adult son of John from a previous relationship and has been appointed John’s alternate director. As an alternate director, Alex would be able to attend board meetings on behalf of John and have the same director powers as John. Sarah also has two daughters from a previous relationship, but neither daughter is involved in the SMSF. John ultimately wants Alex to take over as a director when he dies or loses capacity. Years later, John becomes mentally incapacitated and as a result ceases to be a director since the constitution of the company says that the office of the director becomes vacant when a director dies or becomes mentally incapacitated. Is Alex able to step into the shoes of John?

Unfortunately, the answer is no. On a conservative interpretation of s 201K of the Corporations Act 2001 (Cth) (Corporations Act) (ie the provision dealing with alternate directors) this section provides that an alternate director can only ever exercise the powers of the appointing director as if the powers were exercised by the appointing director him or herself. Therefore, there is a presumption that the appointing director must monitor their alternate director’s actions. In other words, the monitoring by the appointing director is an essential element for an alternate director to be placed. Hence, on the ceasing of the appointing director as a director of the company, the likely scenario, albeit the conservative view, is that the alternate director also ceases since the appointing director is no longer in a position to monitor their alternate director. Therefore, in scenario A, Alex would be unable to step into the shoes of John as a director or exercise any powers on behalf of John since John is no longer a director. This is a problem since John originally wanted Alex to step into his shoes as a fully fledged director. Accordingly, the alternate director loses its succession planning usefulness when the relevant event such as death or loss of capacity happens. Therefore, based on a conservative interpretation of the Corporations Act, what we have in scenario A is a failure of planning where John ceases as a director and Sarah is probably left as the sole director of the company. Alternate director and enduring power of attorney It might be suggested that John appoints Alex as his attorney under an enduring power of attorney to prevent scenario A from happening. Let’s revise our scenario. Scenario B Take the same facts as above. John still appoints Alex as an alternate director but this time, John also appoints Alex as his attorney under an enduring power of attorney. Thus when John loses capacity, Alex, as attorney under the enduring power of attorney, exercises the power attaching to John’s shares and moves to appoint himself as a director of the corporate trustee. However, to be appointed director, the company constitution requires the consent of the majority of shareholders. Since Alex has one share (ie John’s share), he will need Sarah (ie Alex’s step mum) to consent to his appointment to have a majority. There can be

other issues too.

At first glance, an enduring power of attorney appears to be a good solution. Here, Alex has the ability to step into the directorship of John to ensure the member/trustee rules under s 17A of the Superannuation Industry (Supervision) Act 1993 (Cth) (SISA) are met. This is allowed under s 17A(3)(b)(ii) of the SISA, which provides that a person who holds an enduring power of attorney in respect of a member can be a trustee or director of the corporate trustee of a super fund in place of the member without causing the fund to lose its status as an SMSF. But unfortunately, Alex does not become a director automatically just by being John’s attorney. To become a director, under most constitutions, Alex must actually take the necessary steps to be appointed as a director and can only be appointed with the consent of a majority of shareholders or directors, ie Sarah. This would then lead to the following queries: • would Sarah consent to the appointment? • does the company’s constitution allow a vote at a shareholders’ meeting using a proxy or by an attorney under an enduring power of attorney? The other downside to an enduring power of attorney is that it ceases immediately when John dies. An attorney can only act for the donor while the donor is alive. In other words, the enduring power of the attorney only confers Alex the power to act on John’s behalf only while John is alive, but ceases immediately on John’s death. If John dies in scenario B, all sorts of other questions arise, such as: • did John pass his shares in the company to Alex in his Will? • what is the relationship between Alex and Sarah? Do they get along with each other? • does Sarah intend to admit her two daughters as members of the SMSF (and also as directors of the company)? Accordingly, without the right mechanisms, the wrong person will come into control of the SMSF. In scenario B, Sarah is in control of the SMSF. If Sarah is not on good terms with Alex, she can as a sole director (and as 50% shareholder) refuse to allow the appointment of Alex as a director. It would have been simpler if John had appointed Alex as a successor director from the start. As a note, enduring powers of attorney should not be discounted completely. They are certainly very useful while the donor is still alive, particularly when the donor is unable to exercise their powers when they lose capacity. However, until they are appointed as a director, an attorney under an enduring power of attorney may not have any director powers or control in the corporate trustee. Successor directors are better than alternate directors This is the preferred scenario for succession planning; namely John appoints Alex as a successor director from the start. Scenario C Take the same facts as scenario A. This time, John appoints Alex as a successor director, instead of alternate director. John also appoints Alex as his attorney under an enduring power of attorney. When John loses capacity, Alex, as successor director automatically becomes a director of the corporate trustee (and there is no need to appoint Alex by a majority of the members).

In this scenario, Alex automatically becomes a director in place of John without needing to get Sarah’s approval. Here, John’s wish is fulfilled as both Alex and Sarah would be directors on John’s death or when he loses capacity.

Issues with appointing an alternate director On a conservative interpretation of the Corporations Act, an alternate director will cease immediately upon the ceasing of the appointing director (ie they lose capacity or die). While the Corporations Act is silent on when an alternate director ceases, the better view is that where the appointing director ceases, the alternate director would also cease. On reading s 201K of the Corporations Act, the alternate director provision, it provides that a director, with the approval of the other directors, can appoint a person to exercise some or all of the director’s powers for a specified period. The words “specified period” in the provision suggest that an alternate director is only ever meant to be a temporary appointment (ie where a director cannot attend meetings for a short period of time). Further, the section provides that “when an alternate exercises the director’s powers, the exercise of the powers is just as effective as if the powers were exercised by the director”. This suggests that there is an ongoing responsibility of the appointing director to monitor their alternate director. How is a successor director appointed? To appoint a successor director, check the company constitution to see how a successor director is appointed. In all likelihood, most constitutions will be silent on successor directors. If a constitution is silent on successor directors, it isn’t the end of the line. The members of the company can pass a special resolution (plus satisfy any further requirement to pass a special resolution if specified in the existing company constitution) (s 136 of the Corporations Act) to adopt a new constitution with the relevant successor director provisions. A special resolution is a resolution that is passed by at least 75% of the votes cast by shareholders who are entitled to vote on the resolution. Once the successor director provisions are in the company’s constitution, the appointing director can appoint their successor director in line with those provisions. The successor director must of course consent to this appointment. It is important to note that successor directors do not automatically mean a fund will continue to be an SMSF indefinitely. Generally, to fall within this definition, each member must be a trustee or a director of the corporate trustee of the fund. However, the SISA allows a fund to still meet the definition of an SMSF in certain other circumstances.

¶22-055 SMSFs and employee share schemes By Daniel Butler, Director and Gary Chau, Lawyer, DBA Lawyers (November 2016) This article examines whether an SMSF can acquire shares offered under an employee share scheme (“ESS”). What is an ESS? Broadly, an ESS (also known as an employee share plan or employee share ownership plan) typically gives employees the opportunity to purchase shares in their employer. Usually, employees are able to obtain more favourable terms or prices compared to other investors and there can be lower transaction costs. Acquiring shares under an ESS may also be attractive from a tax viewpoint. A person entitled to acquire ESS shares may be eligible for special tax concessions, such as the ability to defer the taxing point. It should be noted that ESS shares may be subject to restrictions on vesting and sale and, in some cases, ESS shares may be forfeited on the happening of certain events (ie when employment ceases). Thus, a careful review should be undertaken on the conditions relating to any shares. Can an SMSF trustee acquire ESS shares from an employee? Under some ESS arrangements, the employee can elect to have an associate (eg a spouse, family company, family trust or SMSF trustee) take up their share entitlement. Even though the associate may

acquire the shares under the ESS directly from the employer, the legal transaction needs to be carefully analysed to ensure there are no superannuation contraventions. The acquisition of shares under some ESS arrangements results in an employee foregoing his/her entitlement to ESS shares to allow an associate to take up the entitlement. Thus, from a legal viewpoint, if the employee’s SMSF acquires ESS shares, this may be considered an acquisition by the SMSF trustee from the employee. The employee is generally taxed in his/her personal tax return on any discount in respect of the initial grant of ESS entitlements. However, under some ESSs, the SMSF trustee may be given a direct entitlement which does not result in an acquisition from a member or related party; whether on a direct or indirect legal analysis. A detailed review of the legal documents and the background facts needs to be undertaken to determine whether the acquisition contravenes superannuation law. Acquiring assets from related parties Since SMSFs have restrictions on acquiring assets from related parties, the SMSF trustee should ensure that they do not contravene s 66 of the Superannuation Industry (Supervision) Act 1993 (Cth) (“SISA”). Section 66 broadly provides: “… a trustee … of a … fund must not intentionally acquire an asset from a related party of the fund. Subsection (1) does not prohibit a trustee … acquiring an asset from a related party of the fund if: the asset is a listed security acquired at market value; or ….” In respect of shares, there is an exception under s 66(2) that allows an SMSF trustee to acquire a “listed security” from a related party, ie a listed share on the ASX provided the acquisition is at “market value”. When an ESS share is offered at a discount, as discussed below, care is needed. Further, s 66(2A)(c) broadly provides that SMSFs are not prohibited from acquiring assets from related parties if the acquisition will not result in the level of in-house assets of the fund exceeding the level of inhouse assets permitted by Pt 8 of the SISA (which is broadly a 5% limit of the fund’s total assets). Under the SISA, a related party includes a member of the fund, a standard employer-sponsor of the fund and a Pt 8 associate of an entity of either the member or the standard employer-sponsor. (An employersponsor is an employer that contributes to an SMSF pursuant to an arrangement between an SMSF trustee and the employer.) Broadly, Pt 8 associates include a company that is controlled, sufficiently influenced by or in which a majority voting interest is held by the member or their Pt 8 associates. Hence, an SMSF trustee should ensure they fall within one of the exceptions to s 66 where there is a direct or indirect acquisition of an ESS entitlement in respect of a member or related party. Where the ESS share is listed, provided the acquisition is at market value, the share can be generally acquired by an employee’s SMSF without contravening s 66. However, where the shares are not listed, an employee’s SMSF may be precluded from acquiring an ESS entitlement that relates to the employee. As discussed, a careful analysis of the legal relationship is required to determine whether the arrangement is one in which there is a direct acquisition by the SMSF from the employee or a related party or it is one in which the SMSF acquires shares directly from the employer (which may, on a legal analysis, be an indirect acquisition from the employee or a related party). Other considerations If shares are acquired by an SMSF trustee at less than market value or for no consideration, the ATO will treat the discount as a personal contribution to the fund by the employee (ie generally a nonconcessional, in-specie contribution). The ATO’s website raises the following query: If the scheme says the member can nominate their SMSF to receive shares or options and the trustee of the SMSF pays no consideration or less than the market value consideration for the shares or share options, the acquisitions by the SMSF result in super contributions if the contributions are made for the purpose of benefitting one or more particular members of the fund, or all of the members in general. Further, the ATO, in TR 2010/1, state that where the capital of the fund increases and the purpose is to

benefit a member or members then a contribution arises. Thus, where an asset, such as ESS shares, is acquired by an SMSF trustee for no or for less than market value consideration, the discount to its market value is generally treated as a contribution. This may result in an SMSF trustee having acquired the ESS shares at market value once the value of the contribution is added to any other consideration paid to acquire the shares. This is important since an acquisition of an asset below market value can result in any dividends or capital gain derived from the asset being taxed as non-arm’s length income (“NALI”), which is discussed below. This “contribution” rule has an important link to the rule in s 66 since a listed security, for instance, can only be acquired from a related party where the security is listed and where it is also acquired at market value. Since many ESS arrangements issue shares at below market value, and s 66 is only satisfied if the shares are acquired at market value, this requirement is satisfied by an employee accounting for the discount as a contribution to their SMSF. Another important consideration is whether NALI can apply to any dividends or capital gains derived in respect of ESS shares by an SMSF. Broadly, NALI can apply where an SMSF trustee acquires the shares below market value, the SMSF trustee and the other party are not dealing at arm’s length or the SMSF trustee derives more ordinary income or statutory income compared to what might have reasonably been expected to derive had the parties been dealing with each other at arm’s length. For example, if the SMSF trustee acquired shares in a private company at 10% of their market value, then all dividends and capital gains would be taxed at 47% even if the SMSF was in pension mode. This was broadly the facts in Darrelen Pty Ltd v Commissioner of Taxation [2010] FCAFC 35 where the court found that private company shares issued to an SMSF trustee for around 10% of the value of the public company shares held by the private company would have its income taxed as NALI (under the former “special income” provision in s 273 of the Income Tax Assessment Act 1936 (Cth) which is now in s 295550 of the Income Tax Assessment Act 1997 (Cth)). Furthermore, if the employee is working in say a small private company for less than his/her market value remuneration and the amount of dividends is greater than arm’s length (especially if the dividends are in lieu of the lower wages), the ATO could seek to tax the dividend and any capital gains on those shares as NALI. The ATO recently issued a Taxpayer Alert TA 2016/6 targeting such arrangements. In particular, the ATO in TA 2016/6 is concerned about arrangements involving an employee or contractor who provides services to an employer or company where, rather than being properly remunerated, the employee or contractor receives a greater dividend from having a shareholding in the employer or principal. The ATO notes in TA 2016/6 that it may apply other anti-avoidance provisions in addition to applying NALI if it comes across this type of activity. ESS arrangements help motivate and align the interests of employees with their employer’s profit motive. Research confirms companies with ESS arrangements generally outperform companies without one. Some companies may even offer share and option arrangements on the basis of a greater return on equity provided the employee contributes “sufficient sweat labour”. However, SMSFs are at risk of NALI being applied if the employee’s remuneration is below market value. The documentation relating to each ESS, including the company’s constitution and any related documents such as shareholders agreement and disclosures, also needs to be carefully reviewed. Typically, ESS terms includes restrictions in respect of the sale or transfer of shares or options which are linked to the employee’s employment (eg the shares must be disposed of if the employee’s employment is terminated or the employer may have a charge or lien in respect of the shares or options). Conclusions SMSF trustees that wish to acquire shares pursuant to an ESS arrangement should be aware of the potential opportunities and risks examined above. A key risk to manage is s 66 of the SISA, which can result in up to one year of imprisonment for anyone involved in the contravention (including an adviser). While we are not aware of anyone being imprisoned in respect of s 66, we are aware of other penalties that have been imposed. Further, the market value of any contribution also has to be considered where there are any discount on ESS shares. This discount is generally assessable to the employee and treated by the ATO as a personal

contribution to the SMSF. There is also a risk of NALI being applied unless all dealings in relation to the employment relationship are on arm’s length terms. This is especially relevant for small private companies where ESSs are designed to motivate and encourage employees to work for less than arm’s length remuneration. Unless all dealings between the company and related parties are at arm’s length and each employee’s remuneration is at arm’s length, the ATO may seek to apply a 47% NALI tax to any dividends and capital gains derived by the SMSF trustee. We recommend that SMSF trustees thinking of investing in ESS shares seek expert legal and tax advice. As discussed above, the detailed terms of the arrangement must be carefully examined to determine whether an employee’s SMSF can exercise any such entitlements.

¶22-060 Pensions from 1 July 2017 — some tips and traps for SMSFs By Philip de Haan, Partner, and Aimee Riley, Lawyer, Thomson Geer (April 2017) The purpose of this article is to discuss some tips and traps that relate to the new superannuation regime starting on 1 July 2017. It deals in particular with payments from self managed superannuation funds (SMSFs) after 30 June 2017, some interesting issues and recent developments in relation to transition to retirement income streams (TRISs). Payments from an SMSF in pension mode under the current law Currently, once a person triggers a relevant condition of release such as retirement or turning 65, he/she may commence to receive an income stream (called a pension in this article). The fund (eg SMSF) should be tax-free (at least in part), the pension income should be tax-free (assuming the person has turned 60), and there is no limit on the maximum pension that may be paid. A payment in commutation of the pension, in whole or part, should also be tax-free assuming the person has turned 60. There is a fair degree of flexibility and the person may generally take out what they like at any time, subject to the minimum pension payment rules. For example, assume John turned 65 and started an account-based pension from his SMSF before 1 July 2017. If he were the only member, the fund should be tax-free, and payments should be tax-free (whether they were pension payments or commutations). He would only need to ensure that he received the minimum pension payment. Assuming John had an account balance of $3m at 1 July 2016, and started the pension on or before then, the minimum pension payment for the year ended 30 June 2017 would be 5% of his account balance at 1 July 2016, ie $150,000.1 Say John wants $300,000 from the fund in the year ended 30 June 2017. He could simply take it out and most likely it would simply be treated as a pension payment. Nothing would turn on whether the amount above the minimum pension payment required were a pension payment or a lump sum resulting from a commutation. As the fund would be fully tax exempt, it would not matter how the trustee funded the payment, eg selling an asset and realising a capital gain. John probably would think it was so simple that he would not seek any advice about the payment. If John only needed the funds for a short time, he could recontribute all or part of the $300,000 by making non-concessional contributions over two years, provided he satisfied the work test.2 Payments from an SMSF in pension mode under the new law The new law will have significant impacts on payments from SMSFs. These impacts relate to properly characterising and documenting what the payments are. If this is not done properly, there will be adverse consequences. For example, assume that John has $3m in his SMSF at 30 June 2017. To comply with the new law, John commutes and internally rolls over $1.4m on 30 June 2017. So at 1 July 2017, John would have a pension account of $1.6m and an accumulation account of $1.4m.3 In accordance with the new law, he would have a transfer balance account at 1 July 2017.4 He would have a credit to his transfer balance account of $1.6m on 1 July 2017.5 This would not exceed his transfer balance cap, which would equal the general transfer balance cap of $1.6m.6 For the year ended 30 June

2018, the minimum pension payment would be 5% of $1.6m, ie $80,000.7 Say John wants $300,000 from the fund in the year ended 30 June 2018. Now he has to determine whether the payment will come from his pension account and/or his accumulation account. He has to take out a minimum pension payment of $80,000, so it would probably be best if he took the $300,000 as a pension payment of $80,000 and a payment from his accumulation account of $220,000. This would enable him to maximise the tax exemptions for the fund by keeping the pension account as high as possible. The trustee of the fund would need to give more thought about how to fund the payment than would be required under the law before 1 July 2017. This is because the fund would not be fully exempt from tax, and it would not be able to use the segregated pension asset method to determine the exemption as John is receiving a pension and he has more than $1.6m in superannuation.8 The proportionate approach means that there will be some type of CGT liability when an asset is disposed of and gives rise to a capital gain (the CGT transitional rules could possibly give some relief). The tax-free proportion of the fund would likely be roughly about 53%, ie 1.6m/3m. Interestingly, if the trustee funds the payment from, say, money at the bank so there is no CGT liability and the payment were from John’s accumulation account, it is likely that the exempt proportion of the fund in the year ended 30 June 2019 would be roughly about 56%, ie 1.52m/2.7m (assuming no income or capital growth). This shows that if someone is going to take payments from an SMSF, payments from an accumulation account should lead to an increase in the proportion of the fund that is exempt. This may impact on the timing of the realisation of any assets subject to CGT. Let us say that John took the $300,000 from his pension account (even though that would not be the best course of action), or that he only had a pension account. It would need to be determined whether the payment was a pension payment or a commutation payment, or a mix of both. If John took the whole payment as a pension payment, then this would have no impact on his transfer balance account, ie the payment would not give rise to a debit to his transfer balance account. As he has fully “used up” his transfer balance cap, this means that he would not be able to increase his pension account, eg start another pension with $220,000. If, however, John took the $300,000 as a pension payment of $80,000 and a commutation of $220,000, he would receive a debit to his transfer balance account of $220,000.9 So, the balance in his transfer balance account would be $1,380,000. This means that he is able to start another pension in the future with a value of $220,000. This would give John greater flexibility for the future. All this shows that the characterisation of a payment from a pension account will be very important under the new law as it will impact upon whether or not there will be a debit to a person’s transfer balance account, and whether or not the person will be able to start a new pension in the future. In this example, John would not be able to recontribute all or part of the $300,000 as a non-concessional contribution, even if he satisfied the work test. This is because after 30 June 2017 a person must have a total superannuation balance at 30 June of the previous financial year of less than the general transfer balance cap in the relevant year ($1.6m for the year ended 30 June 2018) to be eligible to make nonconcessional contributions.10 Documentation requirements under the new law Documentation will be more important under the new law as it will be relevant to: • if the person has a pension and accumulation account, where the payment comes from, and • if the payment is from the pension account and above the minimum pension payment, whether the excess is a pension payment or a commutation lump sum. Trustees of SMSFs will need to ensure that they have appropriate documents to deal with the above. Such documents would include minutes and application forms. The terms of the pensions would also be important.

The timing of when documentation should be prepared will also be important. The ATO may not accept that documentation may be prepared, and payments characterised, when the financial statements for the fund are being prepared, which would often be about nine months after the end of the relevant financial year. In Law Companion Guideline LCG 2016/911, the ATO states that a commutation occurs when the member consciously and validly exercises their right to exchange some or all of their entitlement to receive future income stream benefits for an entitlement to be paid a superannuation lump sum.12 The ATO also refers to Taxation Ruling TR 2013/5 dealing with when a superannuation income stream commences and ceases in which the same view was expressed by the ATO.13 TR 2013/5 seems to indicate that the ATO expects the request to be before the commutation.14 It seems that it will clearly be best if documentation were signed in advance of payments being made, particularly payments above the minimum pension payments required, and especially if the person has an accumulation and a pension account. Perhaps documents could be entered into which indicate that any payments from the fund above the minimum pension payments are payments from the person’s accumulation account, or if from the pension account, are commutations. We expect that the timing and quality of documentation will be a focus of ATO reviews in the future. Transition to retirement income streams and CGT transitional rules TRISs are not treated as superannuation income streams in the retirement phase.15 Accordingly, the transfer balance cap rules do not apply to them, whether they commence after 30 June 2017 or are payable before then and continue after 30 June 2017. Of course, the exemption from tax for a fund paying a TRIS will not apply after 30 June 2017.16 There are CGT transitional rules that apply to funds paying pensions prior to 30 June 2017. The precise rules depend upon whether the fund is using the segregated assets or proportionate method to determine the exemptions prior to 1 July 2017. These rules are beyond the scope of this article. This article will only deal with whether they are capable of applying to a TRIS. It seems clear from the relevant objects clause17 and the Explanatory Memorandum18 that the government’s intention is that a fund paying a TRIS could use the transitional CGT rules. However, for a fund using the segregated assets approach, one of the eligibility criteria is that at some time between 9 November 201619 and 30 June 2017, the asset must cease to be a segregated current pension asset of the fund.20 But the trustee of a fund paying a TRIS does not have to do anything before 1 July 2017. This is because a TRIS may continue to be paid, irrespective of its value, after 30 June 2017 (and it is just that the fund would no longer be exempt from tax after 30 June 2017 in relation to the TRIS). So can it satisfy the CGT concessional rules that apply for segregated assets? The ATO has identified this issue. In Law Companion Guideline LCG 2016/8, it says (at para 22A): “In relation to TRISs, the transitional arrangements are intended to provide CGT relief by enabling complying superannuation funds to reset the cost base of assets to their market value where those assets are re-allocated or re-apportioned from the current pension phase to the accumulation phase in order to comply with the new law. It should be noted that members of funds using the segregated method may receive TRISs during the 2016–17 income year that continue past 1 July 2017 and the TRISs will not be in the retirement phase from that date. That is, the value of the interest supporting the TRIS will not necessarily be transferred to the accumulation phase before 1 July 2017. The Explanatory Memorandum states that the CGT relief is intended to apply to this situation and the Government is currently considering legislative options to clarify this. In view of this, it seems likely that this issue will be resolved by 30 June 2017 and funds paying TRISs and relying on the segregated assets approach for being exempt from tax should be eligible to use the CGT transitional rules.” This problem does not arise for a fund using the proportionate approach for determining its exemption from tax. This is because the relevant provision does not require the trustee to do anything prior to 1 July 2017.21 The ATO accepts that under the new law a problem similar to the one for a fund using the segregated assets method for determining the exemption from tax does not arise.22

Accordingly, it seems that the CGT transitional rules will apply to SMSFs paying TRISs, but some further work needs to be done by the government to clarify this in relation to funds using the segregated assets method for determining the exemption for the year ended 30 June 2017. Starting a pension after 9 November 2016 and the CGT transitional rules If a pension started after 9 November 2016, the fund would not be able to use the transitional rules that apply to segregated assets, because at 9 November 2016 the assets would not be segregated.23 However, the wording of the transitional rules for funds using the proportionate method does not have a similar requirement, though the Explanatory Memorandum gives the impression that the fund needed to be subject to the proportionate method for the entire pre-commencement period, ie from 9 November 2016.24 The ATO considers this in LCG 2016/8. At para 50C, it states: “A particular question raised during consultation on the CGT relief provisions concerned the relevance of commencing a pension (including a TRIS) after 9 November 2016 to the availability of CGT relief under the proportionate method. Generally speaking, merely starting a pension during the pre-commencement period would not be of concern to the ATO from a Part IVA perspective. However, a commutation of the pension shortly after its commencement might be scrutinised more closely if the purpose of such action appeared consistent with obtaining a tax benefit.” For pensions, including TRISs, that start after 9 November 2016, the following needs to be considered: • What type of pension will it be (eg account-based pension or TRIS)? • Will it need to be commuted, at least in part, before 1 July 2017 (eg an account-based pension that will have a value above $1.6m)? • If a TRIS, is there a financial need for the income to be paid to the member? • How much of the fund will be exempt in the year ended 30 June 2017, and will there actually be an advantage in using the CGT transitional rules? We consider that actuarial advice and modelling would need to be done now, to evaluate this if it were going to be recommended to clients. • How will Pt IVA of ITAA 1936 apply? Conclusion After 30 June 2017, it will be important to properly characterise and document payments from SMSFs in pension mode, particularly if the member has an accumulation and pension account. The timing of the documentation is also important. SMSFs that start to pay a pension after 9 November 2016 should carefully consider whether there are any advantages in applying the CGT transitional rules, and if so, carefully consider the application of Pt IVA. Footnotes 1

Regulation 1.06(9A) and Sch 7 Superannuation Industry (Supervision) Regulations 1994 (SISR).

2

Regulation 7.04 item 2 SISR. As John is over 65, he could not use the bring forward rule to contribute the whole $300,000 in one year (s 292-85 Income Tax Assessment Act 1997 (ITAA 1997).

3

The transitional rule that would allow John to have $1.7m in his pension account up to and including 31 December 2017 is ignored in this example. See s 294-30 Income Tax (Transitional Provisions) Act 1997 (ITTPA 1997).

4

Section 294-15 ITAA 1997.

5

Section 294-25 item 1 ITAA 1997.

6

Section 294-35 ITAA 1997.

7

Regulation 1.06(9A) and Sch 7 SISR.

8

Section 295-385(7) and 295-395(3) ITAA 1997.

9

Section 294-80(1) item 1 ITAA 1997.

10

Paragraph 5.5 of the explanatory memorandum that accompanied the Bill (Explanatory Memorandum), s 295-85(2)(b) ITAA 1997.

11

Issued in final form on 10 March 2017.

12

Paragraph 41 LCG 2016/9.

13

See para 110 TR 2013/5.

14

See in particular para 111 TR 2013/5.

15

Section 307-80(3)(a) ITAA 1997.

16

Explanatory Memorandum, para 10.37 and s 307-80(3)(a) ITAA 1997.

17

Section 294-100 ITTPA 1997.

18

Explanatory Memorandum, paragraph 3.321.

19

The beginning of the “re-commencement period” being the day the Bill that became the Treasury Laws Amendment (Fair and Sustainable Supervision) Act 2016 was introduced into the House of Representatives (s 294-105 ITTPA 1997).

20

Section 294-110(1)(b) ITTPA 1997.

21

Section 294-120 ITTPA 1997.

22

LCG 2016/8 para 41–41F.

23

Section 294-110(1)(a) ITTPA 1997.

24

See paragraph 3.343 of the Explanatory Memorandum.

¶22-065 The new super law — what you need to do before 1 July 2017 By Philip de Haan and George Hodson, Partners, Thomson Geer (May 2017) A lot has been said about what needs to be done before 1 July 2017 to deal with the new changes to the super law. The purpose of this article is to provide our view on what should be done before 1 July 2017.

This article is in broad terms only and does not deal with all the relevant issues. What should be done before 1 July 2017 Complying with the $1.6m transfer balance cap If a super fund member is going to have one or more account-based (including the old allocated) pensions with total account balances at 1 July 2017 that exceed $1.6m, then some part of the pension(s) should be commuted before 1 July 2017. This should be done to ensure that the total of such pension account balance(s) does not exceed $1.6m. Note that under transitional rules, the total of such pension account balance(s) can be $1.7m up to 31 December 2017 if certain conditions are satisfied. The consequences of exceeding the cap can be avoided if the commutation occurs. These consequences of exceeding the cap are excess transfer balance tax, an excess transfer balance determination and commutation authority from the ATO. With self managed superannuation funds (SMSFs), it will generally not be possible to know the exact account balances at 30 June 2017. Therefore, the commutation process and documents should comply with the ATO’s guidelines in Practical Compliance Guideline PCG 2017/5. This requires, among other things, complying with the terms of the pension(s) and the super fund trust deed to implement any commutation. It is likely that pension(s) can be commuted without amending the trust deed. However, both the pension terms and the trust deed need to be reviewed to determine what precisely needs to be done. If someone is receiving a non-commutable pension, such as a market-linked pension, special rules impact on the above. Such non-commutable pensions cannot, and do not need to, be commuted to comply with the new law. CGT transitional rules If a super fund is exempt from tax using the segregated assets approach, and it wants to use the CGT transitional rules that will allow a “step-up” to market value of CGT assets, then the fund must, before 1 July 2017, take action so that the relevant asset ceases to be a “segregated current pension asset”. This could involve commuting part of the pension, or making further contributions to the fund. Something needs to be done, even if no member of the fund would have a pension account that would exceed $1.6m. The law is proposed to be changed so that no specific action is required for a super fund that pays a transition to retirement pension, and the fund continues paying the pension at the start of 1 July 2017. However, no exemption will apply for fund earnings that support transition to retirement pensions after 30 June 2017. Nothing in particular needs to be done for the CGT transitional relief if the fund is using the actuarial, proportionate method. Non-concessional contributions For anyone with more than $1.6m in super, this is likely to be the last year in which they can make nonconcessional contributions. Also, the maximum will reduce from $180,000 a year ($540,000 using the bring-forward rule if the relevant criteria are satisfied) to $100,000 a year ($300,000 using the bringforward rule). So this will be the last financial year in which certain people will be able to make nonconcessional contributions, or make such contributions to the level currently allowed. An individual who used the bring-forward rule in 2015/16 or 2016/17 has a “bring-forward” of $540,000 for three financial years. They have until 30 June 2017 to fully utilise this $540,000 cap. From 1 July 2017, an individual who brings their cap forward in 2015/16 will have a revised three-year cap of $460,000, and an individual who brought their cap forward in 2016/17 will have a revised three-year cap of $380,000. Other action Other action that should be considered before 1 July 2017 include: • Selling assets that would not be eligible for the transitional CGT rules (eg assets acquired on or after 9 November 2016). However, you need to take into account the application of the general antiavoidance provisions in Pt IVA and the ATO’s views on “wash sales”.

• Establishing a second SMSF to assist with complying with the new law. However, you need to take into account the application of the general anti-avoidance provisions in Pt IVA and the views already expressed by the ATO about the application of Pt IVA to establishing second SMSFs. • Reviewing lifetime, life expectancy and market-linked pensions being paid by SMSFs and determining whether they should be restructured, and, if so, restructuring them. • “Turning off” transition to retirement pensions if they are no longer appropriate in view of a super fund no longer being entitled to tax exemptions in relation to such pensions after 30 June 2017. Consider, however, whether the pension should be “turned off” after 30 June 2017 in view of the proposed changes to the CGT transitional rules for segregated assets. • Reviewing death benefit and reversionary pension nominations. The added flexibility of administering reversionary pensions may be preferred by fund members over binding death benefit nominations to avoid, among other things, excess transfer balance tax possibly arising upon the death of a member (as discussed below). What does not need to be done but would be a good idea sometime Amending super fund trust deeds It is unlikely that many super fund trust deeds would need to be amended before 1 July 2017, in the sense that they would breach the super or tax law if they were not amended. If a deed contained the rules of a pension that did not allow commutations, and a pension had to be commuted to comply with the $1.6m pension cap or the CGT transitional rules for segregated pension assets, then the deed would need to be amended. But this would be rare. Many, if not most, super fund trust deeds contain provisions that give the trustee the power to comply with the relevant tax and super law as it changes from time to time. So it is unlikely that many deeds would need to be amended to comply with, for example, the new law in relation to excess transfer balance tax, and excess transfer balance determinations and commutation authorities. However, there are some aspects of the new law that provide good reason to amend a deed, at least in relation to certain people receiving pensions. For example: • You generally do not want to exceed the relevant pension cap, currently $1.6m. The deed could have specific provisions dealing with the cap not being exceeded for pensions that commence or continue after 30 June 2017. • Under proposed changes to the law, transition to retirement pensions will automatically become superannuation income streams “in the retirement phase” on the recipient satisfying a condition of release such as retirement (as defined) or turning 65. At that point, the cap rules will be applied, but the fund’s adviser may not know that it has happened. It would generally be beneficial if the deed had automatic commutation provisions in relation to such pensions because if not, commuting would have adverse tax consequences. • After 30 June, it will generally be better for a person to withdraw moneys from their accumulation account(s) rather than pension account(s); anything withdrawn from their pension account(s) above the minimum required to comply with the super law would be better as a commutation payment rather than as a pension payment. This enables better use of the cap rules. It would therefore be beneficial if the deed had automatic payment provisions that dealt with where the payments come from, and what they are. Many funds will not need these enhancements (eg funds with members who would never exceed the $1.6m pension transfer balance cap). However, it will generally cost more to review a super fund deed, consider the members’ particular circumstances, and advise on whether or not the deed needs to be amended than to simply amend the deed. Converting pensions to reversionary pensions Generally, it is better under the new law if pensions automatically revert to a spouse, even if the pension

transfer balance cap would be exceeded. This is because the spouse will have a year from the date of death of the person receiving the pension to sort out what needs to be done. The amount that will be taken into account for the surviving spouse will be the deceased’s pension account balance(s) at the time of death. Automatically reversionary pensions also make it easier to comply with the minimum pension payment rules and the rules relating to tax exemptions for a super fund after the death of a person receiving a pension. However, it is not strictly necessary to rush into converting pensions to reversionary pensions. We consider that this should be done as part of an estate planning exercise, to make sure that all the relevant ramifications are properly considered. Valuations If a member is likely to have a pension account of $1.6m at 30 June 2017, and/or the fund is going to use the CGT transitional rules, the assets of the fund will need to be valued. This does not mean that a valuation needs to be obtained before 1 July 2017. Where the fund has assets such as real estate or units in private unit trusts, the trustee will need to consider how to appropriately value the assets taking into account the ATO’s guidelines on valuing super fund assets, which have been updated to deal with the new law. The trustee should consider, in particular, when a valuation from a qualified valuer should be obtained.

¶22-070 Housing affordability under 2017 Federal Budget superannuation measures By Allan Coe, Senior Content Specialist, Wolters Kluwer CCH (June 2017) The government announced several initiatives in the 2017 Federal Budget that address housing affordability. Proposed initiatives include releasing land currently held by the federal government, changes to planning and zoning, tax changes for foreign investors, and changes to superannuation. Both of the proposed superannuation measures of downsizing the family home and super saver scheme have received significant media attention. While the broader policy of both superannuation changes is publicly available, there is limited information on how each measure will operate in the absence of draft legislation. The measure of downsizing the family home is targeted to retirees and allows individuals to make additional contributions to superannuation through the proceeds of downsizing. This is expected to place more family homes on the market. The first home super saver scheme will allow individuals to save for a home deposit within superannuation, and thus benefit from concessional tax treatment. This enables first home buyers to save a deposit quicker and access the property market earlier. With both superannuation initiatives there are a number of issues and personal circumstances to consider. Downsizing the family home Superannuation contribution through sale of principal residence From 1 July 2018, a person aged 65 or over will be able to make a superannuation contribution up to $300,000 from the proceeds of the sale of their principal residence they owned for at least 10 years. If a couple sell their principal residence they are able to contribute $300,000 each. The superannuation contribution the retiree makes is a non-concessional contribution. Ordinarily, an individual aged over 74 is unable to make a non-concessional superannuation contribution as they fail the age test, while an individual aged 65 to 74 can only make a non-concessional superannuation contribution if they meet the work test. In addition, an individual is only able to make a non-concessional superannuation contribution if their total superannuation balance is less than $1.6m. The age, work and total superannuation balance tests are all relaxed for the purposes of a “downsizing” superannuation contribution, and an individual can make a non-concessional superannuation contribution regardless of whether they meet these eligibility requirements. Downsizing the family home and making a superannuation contribution is mainly beneficial to an individual who is a self-funded retiree who will have $1.6m or less in superannuation after downsizing the family home. This is due to the interaction of this measure with the age pension assets test and the $1.6m transfer balance cap.

Age pension assets test While an individual’s principal residence is excluded from the age pension assets test, any change in an individual’s superannuation balance (including superannuation contributions made from the proceeds of downsizing) will count towards the age pension assets test. The downsizing initiative does not result in a relaxation of the age pension assets test, and these new assets will count. This may impact on a retiree’s ability to access the age pension, and means that downsizing the family home and making a superannuation contribution is mainly beneficial to an individual who is already, or intends to be, a selffunded retiree. Transfer balance cap of $1.6m on assets supporting a retirement income stream The non-concessional superannuation contribution made from downsizing is exempt from the $1.6m total superannuation balance cap (essentially, total amount in superannuation). However, an individual is still subject to the $1.6m transfer balance cap (superannuation in retirement phase). This means an individual with superannuation interests in retirement phase of $1.6m can still make a contribution to superannuation from downsizing, but they will be unable to transfer that amount from accumulation into the retirement phase (having reached their transfer balance cap). Superannuation in the retirement phase is generally tax-free, while tax is imposed on superannuation in the accumulation phase. An individual in these circumstances will therefore be unable to receive the full tax advantage, and will limit the benefit an individual receives from downsizing the family home. First home super saver scheme From 1 July 2017, an individual will be able to make voluntary contributions into their superannuation fund of up to $15,000 per year and up to a maximum $30,000, to be withdrawn, along with associated deemed earnings, for a first home deposit. The contributions must be made within an individual’s existing annual contribution caps. A first home buyer will be able to make a withdrawal from their superannuation fund for deposit from 1 July 2018. If a couple decide to purchase their first home, they can both make a withdrawal. For an individual to use the first home super saver scheme, the superannuation contribution must be a voluntary contribution. The 9.5% compulsory superannuation guarantee contribution made by an employer is not a voluntary contribution and cannot be accessed under the super saver scheme. However, it appears other superannuation contributions made by an employer or employee will be a voluntary contribution. This includes salary sacrificed contributions. While earnings will accrue on the superannuation contribution, it is not the actual earnings that can be withdrawn from the superannuation fund under the super saver scheme. Instead, deemed earnings can be withdrawn for the purpose of a first home deposit. Deemed earnings accrue at the rate of the 90-day bank bill plus three percentage points. Currently the deemed rate is 4.78%. Concessional contributions (including salary sacrificed contributions and personal contributions that an individual has claimed a tax deduction for) will be taxed at 15% in the superannuation fund. The withdrawal will be taxed at an individual’s marginal tax rate, less a 30% tax offset. Non-concessional contributions will not be taxed on entry or exit from the superannuation fund. A withdrawal from superannuation for the purpose of a first home deposit is a withdrawal of capital and as such will not trigger a reduction in social security entitlements. While the concessional part will be included in taxable income it will not flow-through to other income tests, such as HECS/HELP repayments, family tax benefit or child care benefit. What happens if an individual does not purchase a home? Generally, any contribution made to a superannuation fund must stay in the superannuation system until a condition of release is met, such as retirement. For the first home super saver scheme, a new condition of release will need to be legislated which will be a withdrawal for a deposit on a first home. An individual may change their plans about the purchase of a first home. The reason for a change in plans may include a change in life’s circumstances such as a desire to undertake study or travel, loss of employment, relationship breakup, or the property market has moved further and the purchase of a first home is no longer feasible. Also, the government has not stated what the rules will be for when there are

joint purchasers and only one purchaser is a first home buyer. An individual’s new partner may have previously owned a home which may prevent an individual from accessing their superannuation for the joint purchase of a first home. It would appear in each of these circumstances that the superannuation contributions must remain in superannuation until a condition of release is met; possibly retirement. Salary sacrificed amounts An individual can make a voluntary superannuation contribution by salary sacrificing income into an employer superannuation contribution. These salary sacrificed superannuation contributions are in addition to compulsory superannuation guarantee contributions. Employer superannuation guarantee contributions are a compulsory contribution paid by an employer and calculated as 9.5% of ordinary time earnings. Superannuation guarantee contributions are not payable by an employer on salary sacrificed amounts. If an employee increases their voluntary superannuation contributions by salary sacrificing part of their salary package, this may reduce the compulsory superannuation guarantee contribution and thus further increase their voluntary superannuation contribution. For example, an employee who maintains their overall salary package and wishes to make the maximum voluntary contribution of $15,000 may achieve this by salary sacrificing $13,698.63 into superannuation. As the compulsory superannuation guarantee component of the superannuation contribution is calculated on the reduced income, this will reduce the compulsory employer superannuation guarantee contribution by $1,301.37 (9.5% of $13,698.63) and, in turn, effectively convert what was a superannuation guarantee contribution of $1,301.37 into an additional voluntary contribution. Liquidity and volatility within an SMSF If voluntary superannuation contributions are made to an SMSF for the purpose of a first home deposit, the trustees of the SMSF may need to consider their investment strategies and levels of liquidity. The primary intent of a superannuation fund is to provide for the retirement income of a member. Investment strategies would generally be directed to this long-term objective, and it is likely that there would be capital investments and little liquidity in the earlier stages of an individual’s superannuation account, and then a movement from capital to liquidity as the individual nears retirement and will be drawing down on their superannuation account. If the contributions are of a shorter term and will be drawn down for a deposit on a first home, investment strategies will need to be re-thought. There may be a need for increased liquidity in the shorter term and less capital investment. There may also be issues around the volatility of investment returns. Normally, volatility of returns evens out over the duration of an individual’s working life. However, if the superannuation contribution is for a shorter period, volatility may impact the individual’s account balance to a greater extent. As the amount being withdrawn is the amount contributed plus deemed earnings, there may be a significant difference between the amount released and the amount the contribution is now worth. An SMSF may need to maintain liquid assets for a withdrawal that do not match the actual value of the voluntary contribution.

¶22-075 $1.6m super balance transfer cap By Ben Miller, Senior Writer, Wolters Kluwer CCH (June 2017) Since the original announcement in the 2016 Federal Budget, we have had just over a year to get used to the idea of the transfer balance cap. Now the new legislation is upon us. The questions surrounding this new legislation have been varied and expansive. What specifically are the opportunities for clients? The ability to articulate tax changes to your clients, with examples and practical guidance, is invaluable for any major new law coming into effect. The new law The transfer balance cap is a lifetime limit of superannuation an individual can transfer into a tax-free pension account. From 1 July 2017, the $1.6m cap will include the: • value of superannuation interests supporting an income stream on 30 June 2017

• commencement of a new income stream after 1 July 2017, and • value of any reversionary income streams. Any amount in excess of the $1.6m cap will also accrue a notional amount of earnings that will be credited against the cap and no further non-concessional contributions are allowed. Only amounts listed above are “credited” against the $1.6m cap. It has been proposed that the liability amount of limited recourse borrowing arrangements will be “added back” and included in the $1.6m cap. This is yet to pass legislation. Any earnings or income stream payments after 1 July 2017 on pension accounts will not add or reduce the total. Balances above $1.6m in pension phase could be reduced (“debited”) to the balance transfer cap by a full or partial commutation. The amounts could either be transferred back into accumulation phase or paid as a lump sum. TRIS amounts will no count towards the cap until a full condition of release is met. The transfer balance cap will be most important to members who are near or are over $1.6m in superannuation. In these situations, the member will want to know how to best structure their affairs in relation to the cap. The important thing to remember is trying to avoid an excess transfer balance and the associated tax. Example: Calculation of transfer balance cap and tax Daniel is 67 years of age and as at 30 June 2017 has a balance in his SMSF of $1,115,000 in a pension account and $85,000 in accumulation. He has no other balances in superannuation. On 1 July 2017, he makes decisions to commence a new pension for the balance of $1,200,000. Daniel sells his business on 15 February 2018 and is set to make a capital gain of $1,848,000, which is reduced 50% on the CGT general discount and a further 50% active asset test exemption available for small businesses.

Settlement occurs on 15 August 2018 and Daniel receives the proceeds. He elects to use the retirement exemption to disregard the remaining capital gain of $462,000 and contributes that amount into the SMSF. He is under the lifetime limit of $500,000 and can make the contribution as he has passed the work test. Immediately after depositing the $462,000 he commences a new pension. This pension will have a 100% tax-free member component. Transfer balance cap calculation: Account

Commencement

Pension 1

1 July 2017

Pension 2

15 August 2018

Total

Amount $1,200,000 $462,000 $462,000

Transfer balance cap

$1,600,000

Amount cap exceeded

$62,000

By commencing the new pension, Daniel has exceeded the transfer balance cap of $1.6m by $62,000. On 31 August 2018, the ATO issues an excess transfer balance determination as follows: Excess transfer balance Days exceeded

$62,000 16

Accrued notional earnings rate

9.2%

Notional earnings

$250

Crystallised reduction amount

$62,250

On 3 September 2018, Daniel transfers an amount of $62,250 out of pension account number 1 as a lump sum payment, reducing the transfer balance cap under the allowable limit. Excess transfer balance cap tax calculation: Notional earnings

$250

Tax (at 15%)

$37.50

This tax is intended to neutralise the advantage that Daniel received from the fund earning tax-free income while in pension phase. Note: The excess balance tax assessment may be alleviated if Daniel was to make a lump sum withdrawal from pension account number 1 prior to commencing the second pension. However, an interim set of accounts would be necessary to correctly calculate the super balance and make the lump sum. Accountant tip: Legislation prohibits a non-concessional contribution when the balance is above $1.6m. Subject to cash flow, Daniel may be able to make a non-concessional contribution up to his limit prior to making the CGT retirement contribution. Reversionary pensions There are two types of reversionary pensions and their treatment is different for transfer balance cap purposes. In automatic reversions, the value of the income stream counted against the transfer balance cap is the account balance on the date of death of the original spouse. A grace period of 12 months is allowed to get balances under the transfer balance cap after the death. By itself, a binding death benefit nomination does not make a superannuation income stream reversionary. In a non-automatic reversionary benefit, a transfer balance credit arises when the income stream commences on the reversionary pensioner’s behalf. These amounts may include any investment earnings or deposits that increased the deceased member’s balance before commencement of the reversionary pension. This is common where no death benefit nomination is in place, especially in SMSFs so trustees are not bound by a potentially unfavourable decision. In both instances, there is a credit to a member’s transfer balance cap if a reversionary pension is already underway at 1 July 2017. In this instance the credit to the cap is the value of the entire benefit at 1 July 2017, not just the amount that was reverted. Similarly, there is a 12-month grace period should the reversionary pension straddle the 30 June 2017 law change. For example, if a member passes away on 1 January 2017, the automatic credit to the reversionary pensioner will occur on 1 January 2018. In summary, the following table shows the variations based on the type of reversionary pension and when it commenced. Date of death

Automatic reversionary pension

Non-automatic reversionary pension

Before 30 June 2017

Credit to the transfer balance cap is the super balance at 30 June 2017. Surviving member has 12 months from reversion to rectify an excess if reversionary began after 1 July 2016.

Credit to the transfer balance cap is the later of 1 July 2017 and the date the reversionary income stream is granted.

After 1 July 2017

Credit to the transfer balance cap is the super balance at the date of death. Surviving member has 12 months from reversion to rectify any excess.

Credit to the transfer balance cap is the balance of the account when the reversionary income stream is granted.

Example: How the reversionary pension balances will look John has a reversionary pension worth $1.1m at the time of his death on 1 August 2017. The pension reverts to Heather

automatically, who already has a transfer balance account of $1m. Heather is advised that without action the combined pensions added together will cause her to breach the transfer balance cap. She can fully commute either pension or she can undertake a partial commutation for the amount of the potential excess, $500,000. On 1 December 2017, Heather makes a partial commutation of her pension moving $500,000 back into accumulation phase. On that date, a debit in her transfer balance brings her transfer balance account down to $500,000. A $1.1m credit in Heather’s transfer balance account occurs on 1 August 2018 due to the reversionary pension. Heather will not breach her transfer balance cap. For the 2017/18 income year, the SMSF has taxable income of $116,000. During the year, Heather withdraws a total of $66,000 from John’s reversionary pension and $55,000 from her pension account, meeting the minimum draw-down requirements. At the beginning of the year, accounts that funded income streams totalled $2.095m. The calculation of the member’s account share of the fund for the 2017/18 income year is as follows:

John

Heather

Heather

(reversionary)

Pension

Accumulation

1,095,000

1,000,000

–

2,095,000

–

(500,000)

500,000

–

(66,000)

(55,000)

–

(121,000)

Closing balance

1,029,000

445,000

500,000

1,974,000

Average balance

1,062,000

722,500

250,000

2,034,500

Average balance %

52.20%

35.51%

12.29%

60,552

41,192

14,256

Opening balance Transfer Pensions

Income

Fund

116,000

At the end of the year, an actuary calculates that the current exempt pension percentage of the fund is 87.71%. The taxable income is $14,256, with 15% tax equaling $2,138.40. As the transfer between pension account and accumulation account occurred after 1 July 2017, there is no CGT relief (as no balance transfer cap was breached). Tip: Most reversionary pensions are binding and would not allow a partial lump sum. In these situations, the trustee of the fund may be bound by the direction of the nomination, as opposed to having discretion on how to handle the affairs of the fund once a member dies. Other considerations should be given to members’ taxable components. CGT relief Transitional CGT relief will apply where the assets of the fund are required to be moved from pension phase (where CGT is disregarded) to accumulation phase. A superannuation fund trustee could choose to reset the cost base of an asset before 1 July 2017 so that any unintended taxes are mitigated. The relief applies whether the fund is fully segregated or unsegregated, but their calculations are different. Example: Applying CGT relief in full pension phase Belinda is the sole member of an SMSF, which is in 100% pension phase and fully segregated. The accounts for the 2015/16 income year were prepared, with the assets as follows:

Asset

Cost base

Market value

Non-commercial property

$850,000

$1,050,000

Shares in listed companies

$650,000

$650,000

Cash and equivalents

–

$200,000

Total value of assets/member’s balance

–

$1,900,000

By 1 July 2017, Belinda is required to reduce her pension account to $1.6m in accordance with the legislation. She draws up the following resolution: “As at 30 June 2017, the fund is to revert all of my pension account back into accumulation phase, and commence a new pension for $1.6m.” The fund is now unsegregated and Belinda chooses to reset the cost base of both assets at 30 June 2017. The fund is in 100% pension phase for the 2016/17 income year, meaning any capital gains will be disregarded. On 30 June 2017, the assets are: Asset

Cost base Market value

Non-commercial property

$1,200,000

$1,200,000

$700,000

$700,000

–

$100,000

Shares in listed companies Cash and equivalents

Total value of assets

–

$2,000,000

Belinda’s member balance Pension

$1,600,000

Accumulation

$400,000

Total member balance

$2,000,000

In the 2019/20 year, Belinda sells the non-commercial property for $1.4m. The capital gain is included in the annual return as follows: Proceeds

$1,400,000

Less: Cost base (reset at 30 June 2017)

$1,200,000

Costs of sale

$20,000

Total cost base

$1,220,000

Gross capital gain

$180,000

⅓ discount applies

($60,000)

Net capital gain

$120,000

Less: ECPI (70%)

($84,000)

Taxable gain

$36,000

Tax (15%)

$5,400

The 70% ECPI represents an actuarial percentage for that year, assuming the percentage reduces due to pension withdrawals. Example 2: Two members using proportionate method In this example, the SMSF has a second member, Deidre, with an accumulation balance of $1m. The assets of the fund at 30 June 2017 is as follows:

Asset Non-commercial property Shares in listed companies Cash and equivalents

Original cost Reset cost base

Market value

$850,000

$1,200,000

$1,200,000

$1,300,000

$1,500,000

$1,500,000

–

–

$300,000

Total value of assets

$3,000,000

Belinda — Pension

$1,600,000

Belinda — Accumulation

$400,000

Deidre — Accumulation

$1,000,000

Total member balance

$3,000,000

Assuming the ECPI percentage is 67% for the 2016/17 income year, a capital gain occurs for the assets of the fund where CGT relief has been applied. The fund is required to calculate the assessable income for the assets as if they were sold in the 2016/17 year.

The capital gain for the non-commercial property is $350,000. Assuming the general discount (1/3) would apply, the assessable income for the year would have been ($350,000 × 2/3 × 33%) $77,000. Using the same method the shares would have assessable income of $44,000. The $121,000 capital gain can be deferred until the assets are eventually sold. As per the above example, in the 2019/20 year, the fund sells the non-commercial property for $1.4m. The calculation of the capital gain is as follows: Proceeds

$1,400,000

Less: Cost base (reset at 30 June 2017)

$1,200,000

Costs of sale Total cost base

$20,000 $1,220,000

Gross capital gain Deferred assessable income

$180,000 $77,000

Total capital gain

$257,000

⅓ discount applies

($86,000)

Net capital gain

$171,000

The tax payable in this example is dependent on what the ECPI percentage is for the 2019/20 tax year. The exempt percentage can change from year to year based on the actions of the members. Therefore, if Deidre had retired by meeting preservation age and no longer intending to be gainfully employed, the exempt percentage could be drastically different. In the example, if Deidre was still in accumulation phase, the ECPI% would be 50%, making a taxable gain of $85,500 and tax payable of $12,825 on sale of the property. If Deidre had retired and commenced an income stream, the ECPI% would be 85% and tax payable would be $3,847.50. Conclusion Several factors need to be considered before a trustee decides the best outcome going forward in their circumstances. Firstly, as these changes relate to a member’s pension, the first point of review should be around matching the required living expenses to the cash flow requirements of the fund, and start from there. An option may be to remove the portion of the balance of a superannuation account into the hands of the individual member. This may have a beneficial outcome due to the individual marginal tax rates, but may no longer have the benefit of asset protection from creditors outside superannuation. Estate planning also needs to be considered. The above also suggests that for funds that are currently in 100% pension phase, moving back to unsegregated method could create benefits with CGT relief on superannuation assets. Trustees must take care and remember that the decision for CGT relief is irrevocable. Most importantly, keeping timely up-to-date records of your SMSF member’s account balances will be imperative going forward and may provide you with opportunities to monitor them now and throughout the ensuing years. It is advised that practitioners review all their clients’ superannuation balances, whether or not they have an SMSF. Finally, make sure you ask questions to your clients. Do they have any balances sitting in a retail fund? Did they ever work for the government?

Have they checked recently? Only when you have the complete understanding of the overall affairs of your client’s superannuation situation is when you can best advise them of the traps and opportunities.

¶22-080 Benefit of proactive commutation of super interests when over $1.6m in retirement phase By Allan Coe, Senior Content Specialist, Wolters Kluwer (July 2017) As of 1 July 2017, the transfer balance regime is operating. If you had retirement phase interests that exceeded $1.6m on 1 July 2017, you are over your cap and may be subject to the 15% excess transfer balance tax. This tax will continue to accrue until the excess is commuted. You have the choice of either proactively commuting the excess or waiting for the ATO to issue a determination advising of the excess that needs to be commuted. This article highlights the benefit of proactively commuting the excess to bring your account balance within the cap. Excess transfer balance tax is calculated at 15% of your excess transfer balance earnings, and the tax continues to accrue from the date of excess up to the date your excess is commuted. Your excess transfer balance earnings are calculated daily as the amount of excess multiplied by the general interest charge. This is regardless of the actual earnings (or losses) experienced by your fund and your superannuation account. The general interest charge for the current quarter is 8.73% per annum, or a daily rate of 0.02391781%. Excess transfer balance earnings are added back to your transfer balance account each day as a transfer balance credit, thus increasing your excess and creating a compounding effect. If you have an excess, the ATO can issue you with a determination which will advise you of the amount of excess and amount that needs to be commuted. However, the ATO will not know you have an excess until all of your superannuation funds have reported to them. The ATO states in its “frequently asked questions” that superannuation funds may not report to them until the end of the 2017/18 financial year, and as such the ATO determination may be over twelve months after the excess first arose. In the meantime, your excess and tax continue to increase. The following examples highlight the difference between proactive commutation and waiting for an ATO determination. Transfer balance account over $1.6m but not more than $1.7m If you were over $1.6m but not over $1.7m on 1 July 2017 you may not have to pay any tax on the excess. Under transitional arrangements, you have until 31 December 2017 to commute the excess and bring yourself under the cap. If you do this, excess transfer balance earnings are not added to your transfer balance account and no tax is payable. However, to take advantage of this transitional relief you must not commence a further superannuation income stream and you must rectify this minor breach before 31 December 2017. This due date of 31 December 2017 for rectification may be before you have received an ATO determination. If you commute before 31 December 2017, the amount you need to commute is the amount you were over the cap on 1 July 2017. This is because excess transfer balance earnings are not added to your account under the transitional arrangements. However, if you commute after 31 December 2017 excess transfer balance earnings (and tax) accrue from 1 July 2017, and a larger amount needs to be commuted. Transfer balance account over $1.7m If you had a transfer balance account over $1.7m on 1 July 2017, you are over the $1.6m cap and do not have the benefit of the transitional relief. The tax is calculated at 15% of your excess transfer balance earnings, and the tax continues to accrue until your excess is commuted. Over $1.7m and ATO has not issued a determination You can commute the excess over $1.6m prior to the ATO issuing you with a determination. An earlier commutation will reduce the amount you need to commute and lower your tax bill.

For example, if you had a transfer balance of $2m (and hence an excess of $400,000) on 1 July 2017, this would accumulate excess transfer balance earnings of $95.67 ($400,000 × 0.02391781%) at the end of that first day and you would have a transfer balance account of $2,000,095.67 on 2 July 2017. If you commuted your excess one month later on 1 August 2017, your transfer balance account would have grown to $402,976.50 due to the addition of excess transfer balance earnings of $2,976.50 (($400,000 × 1.000239178131) − $400,000). When you commute your excess to bring it back within your cap you need to commute both the original excess and the excess transfer balance earnings. As such, you need to commute $402,976.50 on 1 August 2017. An excess transfer balance tax of 15% is applied to the notional earnings of $2,976.50 resulting in a tax bill of $446.47. Over $1.7m and ATO has issued a determination If you have an excess over the $1.6m cap, the ATO can issue you with a determination which will advise you of the amount of excess that needs to be commuted. The size of your excess will crystalise upon the issuing of the determination from the ATO. This makes it easier as there is certainty around the dollar amount to be commuted. However, the tax will continue to accrue (and compound) beyond the date of the determination and up to the date the excess is commuted. If you receive a determination advising of an excess to be commuted, you have the options of doing nothing and allowing the ATO to direct a fund to commute after 60 days, advising the ATO of a different income stream to commute, or proactively directing your fund to commute and advising the ATO of the commutation. Taking the earlier example, if a commutation notice issued on 1 August 2017 for $402,976.50, further tax of $873.60 would accrue in the 60 days after 1 August 2017 resulting in a total tax bill of $1,320.07. This compares to a tax bill of $446.47 if you commuted when you received the determination on 1 August 2017. While the amount you need to commute remains the same, proactive commutation by yourself rather than waiting 60 days for the ATO to direct a commutation will result in a lower tax bill. Other relevant information There are a few other points to consider: • you cannot claim a tax deduction for the excess transfer balance tax • the date of commutation is not when you instruct the fund to commute, but rather when the fund actually makes the commutation. The responsiveness of your fund needs to be taken into account when calculating the excess that you need to commute • if you have received a determination from the ATO and decide to proactively commute, you must notify the ATO in the approved form of your commutation (at the time of writing, the ATO has not released this approved form). Otherwise you run the risk that the ATO does not have full information and still acts on his determination and directs a second commutation, and • if you were previously subject to excess transfer balance tax, then the rate of tax increases from 15% to 30% in future financial years. Summary Excess transfer balance tax continues to accrue until the excess is commuted. Even when the ATO has issued a determination, proactively commuting to bring your transfer balance account within your cap could reduce the amount of excess transfer balance tax.

¶22-085 Demystifying the tax treatment of death benefits paid to the estate By Joseph Cheung, Lawyer and William Fettes, Senior Associate, DBA Lawyers (August 2017) The tax treatment of death benefits paid from an SMSF to a deceased member’s estate can be complex. Tax law contains a “look through” provision in respect of death benefits paid to an estate (ie to a legal

personal representative being the executor of a will or the administrator in the case of intestacy). This article examines the key criteria of this “look through” provision and the resulting tax treatment. “Look through” provision for death benefits paid to the estate The relevant provisions that deal with death benefits paid to an estate are contained in Div 302 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997). Relevantly, s 302-10 provides: (2) To the extent that 1 or more beneficiaries of the estate who were *death benefits dependants of the deceased have benefited, or may be expected to benefit, from the *superannuation death benefit: (a) the benefit is treated as if it had been paid to you as a person who was a death benefits dependant of the deceased; and (b) the benefit is taken to be income to which no beneficiary is presently entitled. (3) To the extent that 1 or more beneficiaries of the estate who were not *death benefits dependants of the deceased have benefited, or may be expected to benefit, from the *superannuation death benefit: (a) the benefit is treated as if it had been paid to you as a person who was not a death benefits dependant of the deceased; and (b) the benefit is taken to be income to which no beneficiary is presently entitled. Section 302-10 focuses on two questions, namely: • Are the beneficiaries death benefits dependants? • To what extent have the relevant beneficiaries “benefited, or may be expected to benefit” from the superannuation death benefit? Death benefits dependant The definition of a death benefits dependant is found in s 302-195 of the ITAA 1997. Broadly, a death benefits dependant, of a person who has died, is: • the deceased person’s spouse or former spouse • the deceased person’s child, aged less than 18 • any other person with whom the deceased person was in an interdependency relationship with just before he/she died, or • any other person who was a dependant of the deceased person just before he/she died. If the beneficiary is a death benefits dependant, s 302-10(2) will need to be considered. If the beneficiary is not a death benefits dependant, s 302-10(3) will need to be considered. Benefited, or may be expected to benefit The tax treatment of death benefits paid to the estate does not simply turn on the number of beneficiaries of the estate who are death benefit dependants versus the number of beneficiaries who are not death benefit dependants. Rather, the tax treatment of any death benefits proceeds that are paid to the estate depends on the extent to which death benefit dependants have benefited or may be expected to benefit from the proceeds. This will need to be calculated. In some circumstances, particularly where multiple beneficiaries and testamentary trusts are involved, the calculation process will be complex and may require actuarial input. Tax treatment Once the calculation is performed, any proceeds paid to the estate from which death benefits dependants have benefited or may be expected to benefit are:

• treated as if they had been paid to a death benefits dependant of the deceased, and • not included in the assessable income of the estate (ITAA 1997 s 302-60). For any death benefits paid to the estate where death benefits dependants do not benefit or may not be expected to benefit, the tax treatment of such proceeds depends on the nature of the lump sum amount that was paid to the deceased’s estate. Accordingly, the tax treatment of the super proceeds will be as follows (based on the nature of the lump sum): • any tax free component of the amount is not included in the assessable income of the deceased’s estate (ITAA 1997 s 302-140) • any taxable component (element taxed in the SMSF) of the amount is included in the assessable income of the deceased’s estate, but the estate is entitled to a tax offset to ensure that the rate of income tax does not exceed 15% (ITAA 1997 s 302-145(2)) • any taxable component (element untaxed in the SMSF) of the amount would be included in the assessable income of the deceased’s estate and the estate would be entitled to a tax offset to ensure that the rate of income tax does not exceed 30% (ITAA 1997 s 302-145(3)). An element untaxed in the fund is rare in an SMSF context and typically only arises if deductions were ever claimed in respect of policy premiums for a life insurance policy held in the SMSF. For completeness, it should be borne in mind that any death benefits paid to an estate do not attract the Medicare levy. The following example demonstrates the application of the “look through” provision and the resulting tax treatment. Example Alfred was 66 years old when he died. He was a member of Alfred Superannuation Fund. Alfred did not complete a (binding or nonbinding) death benefit nomination in respect of his entitlements in the Alfred Superannuation Fund prior to his death. Accordingly, the trustee of the Alfred Superannuation Fund exercises its discretion and pays Alfred’s death benefits to Alfred’s estate pursuant to the governing rules of the fund. The sum of $100,000 that is paid to the estate comprises 50% tax free component and 50% taxable component (element taxed in the Fund). The beneficiaries named in Alfred’s last will are: his wife Diana, his two sons Bruce (17 years old) and Clarke (15 years old), and his best friend Robin (50 years old and not a dependant for tax purposes). The will provides that Alfred’s superannuation death benefits proceeds are to be divided as follows: Diana ($90,000) and Robin ($10,000). Applying the “look through” provision, Diana, Bruce and Clarke would meet the definition of death benefits dependant under s 302195 of the ITAA 1997. However, of these death benefits dependants, only Diana may be expected to benefit from the superannuation death benefits proceeds. Accordingly, the $90,000 to be paid to Diana would not be included in the assessable income of the estate. The $10,000 to be paid to Robin will comprise $5,000 tax free component and $5,000 taxable component (element taxed in the Fund). The $5,000 tax free component is not included in the assessable income of the deceased’s estate. The $5,000 taxable component (element taxed in the Fund) is included in the assessable income of the deceased’s estate, but the estate is entitled to a tax offset to ensure that the rate of income tax does not exceed 15% pursuant to s 302-145(2) of the ITAA 1997.

Conclusion Where any superannuation proceeds are paid to an estate, the tax payable in respect of the death benefit proceeds will depend on whether the ultimate recipient of the superannuation proceeds is a death benefits dependant. This is a complex area of law and where in doubt, expert advice should be obtained. Note: DBA Lawyers hold SMSF CPD training at venues all around. For more details or to register, visit www.dbanetwork.com.au or call (03) 9092 9400.

¶22-090 Changed salary sacrifice rule reduces amount released under first home super saver scheme

By Allan Coe, Senior Content Specialist, Wolters Kluwer CCH (October 2017) From 1 July 2018, individuals will be able to withdraw eligible super contributions made since 1 July 2017 for the purchase of a first home. Up to a limit, the amount that can be released is known as the releasable amount, which is the sum of an individual’s eligible non-concessional contributions (post tax contributions) plus 85% of an individual’s eligible concessional contributions (pre-tax or salary sacrificed contributions, but does not include mandated or superannuation guarantee (SG) contributions). In addition, associated earnings can be also released. The focus of this article is how proposed changes to salary sacrifice rules will change the definition of mandated contributions from 1 July 2018, resulting in a lesser amount being released for a first home where contributions are made after this date. SG and salary sacrifice Currently, an employer is mandated to make a 9.5% SG contribution on the ordinary time earnings of an employee. Ordinary time earnings do not include salary sacrificed amounts. However, there is a proposal (currently in Bill form) that from 1 July 2018 the mandated SG contribution is also calculated on super salary sacrificed amounts. While this change is generally a win for employees as it increases mandated SG contributions, the flipside is that this reduces eligible concessional contributions (non-mandated contributions) that can be released. The example below illustrates that the amount released for the purchase of a first home may be 9.5% less under the proposed changes.

Example: Same salary sacrifice contribution in different years leads to different releasable amount Susan’s employment contract entitles her to a salary package of $109,500 a year from her employer which is currently comprised of $100,000 salary and $9,500 super. As this $9,500 contribution is a mandated SG employer contributions (9.5% of $100,000) there is no amount eligible for release. Susan is not entitled to access this super under the first home super saver scheme. Susan decides she wants to salary sacrifice $12,000 of her $109,500 salary package into super with an intent to access these contributions and earnings for the purchase of a first home. Susan enters a new employment contract so that her $109,500 salary package now comprises $88,000 salary and $21,500 super (original $9,500 plus sacrificed $12,000). Susan enters into this super salary sacrifice arrangement for the 2017/18 and 2018/19 financial years.

Releasable amount for contributions before 1 July 2018 salary sacrifice changes Under Susan’s new employment contract her employer makes a $21,500 super contribution which is a mix of mandated SG contributions (not eligible for release) and non-mandated contributions (eligible concessional contributions which can be released). For 2017/18, the mandated SG contributions are 9.5% of Susan’s ordinary time earnings. Susan’s $12,000 salary sacrifice has reduced her ordinary time earnings from $100,000 to $88,000, which requires a mandated 9.5% SG contribution of $8,360 (instead of previous $9,500). Susan’s eligible concessional contributions (non-mandated contribution) is $13,140 ($21,500 super contribution less $8,360 mandated contribution). The releasable amount is 85% of eligible concessional contributions, which means that in the future Susan can withdraw 85% of $13,140 plus earnings under the first home super saver scheme. Releasable amount for contributions after 1 July 2018 salary sacrifice changes As per the previous financial year, Susan’s employer makes a $21,500 super contribution which is a mix of mandated SG contributions and non-mandated contributions. However, unlike the previous financial year, the mandated SG contribution for 2018/19 are calculated on ordinary time earnings plus any salary sacrificed amount. The mandated 9.5% SG contribution is therefore calculated on $100,000 ($88,000 ordinary time earnings plus $12,000 super salary sacrificed) and is $9,500. Only the salary sacrificed $12,000 ($21,500 super contribution less $9,500 mandated contribution) is an eligible concessional contribution (non-mandated) and counts when determining the releasable amount. Susan can withdraw 85% of the $12,000 plus earnings under the first home super saver scheme. Consequence of the salary sacrifice change for first home buyers In our example, Susan makes the same salary sacrificed superannuation contribution in both financial years. For contributions made in the 2017/18 financial year the releasable amount is 85% of $13,140. For contributions made in the 2018/19 financial year, the releasable amount is 85% of $12,000. The releasable amount for Susan is 9.5% less for salary sacrificed contributions made from 1 July 2018.

If an individual is salary sacrificing with an intent to use the first home super saver scheme, there is a greater amount that can be released for contributions made in the 2017/18 financial year compared to future financial years. This is due to mandated contributions being calculated in the future on ordinary time earnings plus salary sacrificed amount, thus reducing the eligible concessional contributions (nonmandated), and lessening the releasable amount for a first home by 9.5%. Other things to consider In addition to a larger amount being withdrawn for contributions made in the 2017/18 financial year, associated earnings can also be withdrawn which further increases the attractiveness of superannuation contributions in the current financial year. However, there are a few things for an individual to consider. Firstly, both the first home super saver scheme and the salary sacrifice changes are in Bill form and neither are law at this time. There may be amendments made prior to these proposals becoming law. Secondly, the above analysis assumes that the employer will maintain the overall salary package for the employee and does not utilise the salary sacrificed amounts to satisfy their SG obligations. Finally, there is a contribution limit of $15,000 per financial year that can be withdrawn. If the salary sacrificed amount is in excess of this limit, then these limits will apply for each financial year.

FEDERAL BUDGET ¶23-060 2016 Federal Budget The Federal Treasurer, Mr Scott Morrison, handed down his first budget at 7.30 pm (AEST) on 3 May 2016. The Budget sets out the government’s plan to transition the economy from the mining investment boom to one that is stronger and more diversified. It does this by: (1) introducing a 10-year enterprise tax plan; (2) fixing problems in the tax system; and (3) ensuring that the government lives within its means. Click on the link to see the full version of the CCH Federal Budget Report. The full Budget papers are available at www.budget.gov.au and the Treasury ministers’ media releases are available at ministers.treasury.gov.au. The tax and superannuation highlights are set out below. Multinational profit shifting and international A 40% tax on the profits of multinational corporations that are artificially diverted from Australia will be introduced from 1 July 2017. Transfer pricing rules will be amended to give effect to OECD recommendations, effective from 1 July 2016. Rules developed by the OECD to eliminate hybrid mismatch arrangements will be implemented from 1 January 2018. Administrative penalties imposed on significant global entities will be increased from 1 July 2017. Small business The small business entity turnover threshold will be increased from $2m to $10m from 1 July 2016 for the purposes of accessing certain existing income tax concessions. The increased threshold will not apply for the purposes of accessing existing small business capital gains tax concessions. The unincorporated small business tax discount will be increased in phases over 10 years from the current 5% to 16%, first increasing to 8% on 1 July 2016. The current cap of $1,000 per individual for each income year will be retained. GST reporting requirements for small businesses will be simplified from 1 July 2017. Other enterprises The company tax rate will be progressively reduced to 25% over 10 years. Targeted amendments will be made to improve the operation and administration of integrity rules for closely-held private groups (in Div 7A of the Income Tax Assessment Act 1936) from 1 July 2018. Tax incentives for investing in early stage innovative companies are to be expanded. Funding arrangements to attract more venture capital investment will be expanded. A new tax and regulatory framework will be introduced for two new types of collective investment vehicles. The proposed measure addressing the double counting of deductible liabilities under the tax consolidation regime announced in the 2013/14 Federal Budget will be modified. The treatment of deferred tax liabilities under the tax consolidation regime will be amended. An integrity measure concerning liabilities arising from securitisation arrangements announced in the 2014/15 Federal Budget will be extended to also apply to non-financial institutions with securitisation arrangements. The taxation of financial arrangements (TOFA) rules will be reformed and new simplified rules will apply from 1 January 2018.

The tax treatment of asset-backed financing arrangements such as deferred payment arrangements and hire purchase arrangements will be amended. Individuals and families The threshold at which the 37% marginal tax rate for individuals commences will increase from taxable income of $80,000 to $87,000 from 1 July 2016. The low income thresholds for the Medicare levy and surcharge will increase from the 2015/16 income year. The pause in the indexation of the income thresholds for the Medicare levy surcharge and the private health insurance rebate will continue for a further three years from 1 July 2018. Income tax exemptions will be provided for ADF personnel deployed in Afghanistan, the Middle East and in international waters. Six organisations have been added to the list of specifically-listed deductible gift recipients. Superannuation The threshold at which high-income earners pay additional contributions tax will be lowered to $250,000 from 1 July 2017. The annual cap on concessional superannuation contributions will also be reduced to $25,000. The tax exemption on earnings of assets supporting Transition to Retirement Income Streams will be removed from 1 July 2017. A lifetime non-concessional contributions cap of $500,000 will be introduced. The current restrictions on people aged 65 to 74 making superannuation contributions for their retirement will be removed from 1 July 2017. Individuals with a superannuation balance less than $500,000 will be allowed to make additional concessional contributions where they have not reached their concessional contributions cap in previous years, with effect from 1 July 2017. From 1 July 2017, all individuals up to age 75 will be allowed to claim an income tax deduction for personal superannuation contributions. A low income superannuation tax offset (LISTO) will be introduced to reduce tax on superannuation contributions for low-income earners from 1 July 2017. The income threshold for the receiving spouse (whether married or de facto) of the low income spouse tax offset will be increased to $37,000 from 1 July 2017. A balance cap of $1.6m on the total amount of accumulated superannuation an individual can transfer into the tax-free retirement phase will be introduced from 1 July 2017. The anti-detriment provision in respect of death benefits from superannuation will be removed from 1 July 2017. GST and other indirect taxes GST will be extended to low value goods imported by consumers from 1 July 2017. A discussion paper on the “double taxation” of digital currencies under the GST regime has been released. Tobacco excise and excise-equivalent customs duties will be subject to four annual increases of 12.5% from 1 September 2017. The wine equalisation tax (WET) rebate cap will be reduced to $350,000 on 1 July 2017 and to $290,000 on 1 July 2018. The excise refund scheme will be extended to domestic distilleries and producers of low strength fermented beverages such as non-traditional cider from 1 July 2017. Access to refunds under the Indirect Tax Concession Scheme has been granted or extended to diplomats

and consuls from Cyprus, Estonia and Finland as well as the Organisation for the Prohibition of Chemical Weapons. Tax administration A Tax Avoidance Taskforce will be established within the ATO to undertake enhanced compliance activities targeting multinationals, large public and private groups, and high-wealth individuals. Individuals who disclose information on tax avoidance to the ATO will receive stronger protection under the law from 1 July 2018. The government is encouraging all companies to adopt the Tax Transparency Code (TTC) from the 2016 financial year. The operation of the Australian Public Service including the ATO will be reviewed to achieve efficiencies and manage their transformation to a more modern public sector.

¶23-065 2017 Federal Budget The Federal Treasurer, Mr Scott Morrison, has handed down his second Budget (the government’s first of its three-year term) at 7.30 pm (AEST) on 9 May 2017. Mr Morrison said the Budget is focused on boosting the economy and households, so that “we live within our means and are able to return the Budget to balance in 2020/21”. The government is proposing to address the housing affordability crisis with a package of tax, superannuation and other measures. Additionally, the Budget contains measures intended to ensure the integrity of the tax and superannuation system. Click on the link to see the full version of the CCH Federal Budget Report. The full Budget papers are available at www.budget.gov.au and the Treasury ministers’ media releases are available at ministers.treasury.gov.au. The tax, superannuation and social security highlights are set out below. Housing affordability measures • A limited amount of an individual’s superannuation contributions made from 1 July 2017 may be withdrawn from 1 July 2018 onwards for a first home deposit. • A person aged 65 or over can contribute up to $300,000 from the proceeds of the sale of their home as a non-concessional contribution into superannuation from 1 July 2018. • Deductions for travel expenses related to inspecting, maintaining or collecting rent for a residential rental property will be disallowed from 1 July 2017. • Plant and equipment depreciation deductions will be limited to outlays actually incurred by investors in residential real estate properties from 1 July 2017. • Managed investment trusts will be able to invest in affordable housing, allowing investors to receive concessional tax treatment, provided certain conditions are met, including that the properties are let as affordable housing for at least 10 years. • The CGT discount for Australian resident individuals investing in qualifying affordable housing will be increased from 50% to 60% from 1 January 2018. • Foreign and temporary tax residents will be denied access to the CGT main residence exemption. • The foreign resident CGT withholding rate will be increased to 12.5% and will apply to Australian real property and related interests valued at $750,000 or more. • An annual levy of at least $5,000 will be imposed on foreign owners of under-utilised residential property. • A 50% cap on foreign ownership in new developments will be introduced through a condition on new dwelling exemption certificates. • The principal asset test in Div 855 of the Income Tax Assessment Act 1997 will be applied on an

associate inclusive basis for foreign tax residents with indirect interests in Australian real property. Tax integrity measures • The multinational anti-avoidance law will be amended to prevent the use of foreign trusts and partnerships in corporate structures for tax minimisation, with retrospective effect from 1 January 2016. • Hybrid mismatch rules used by banks to minimise tax in cross-border transactions will be prohibited from 1 January 2018. • The government will provide $28.2m to the ATO to target serious and organised crime in the tax system. • The Black Economy Taskforce has delivered an interim report to the government and the government has accepted some recommendations for immediate action. • The taxable payments reporting system will be extended to contractors in the courier and cleaning industries from 1 July 2018. • Sales suppression technology and software, used to understate business income by deleting electronic transactions, will be prohibited. • Funding for the ATOs Black Economy Taskforce audit and compliance activities will be extended until 30 June 2018. • A two-year public information campaign from 2016/17 will highlight the governments key tax integrity measures. Small business • Access to the small business CGT concessions will be tightened from 1 July 2017 to deny eligibility for assets which are unrelated to the small business. • The $20,000 instant asset write-off for small business will be extended by 12 months to 30 June 2018, for businesses with an aggregated annual turnover of less than $10m. GST • Purchasers of new residential properties or new subdivisions will be required to remit the GST directly to the ATO as part of settlement from 1 July 2018. • The GST treatment of digital currency (such as Bitcoin) will be aligned with that of money from 1 July 2017. • Access to diplomatic and consular concessions under the Indirect Tax Concession Scheme has been extended. Superannuation • The use of limited recourse borrowing arrangements will be included in a members total superannuation balance and transfer balance cap from 1 July 2017. • Opportunities for members to use related party transactions on non-commercial terms to increase superannuation savings will be reduced from 1 July 2018. • The current tax relief for merging superannuation funds will be extended until 1 July 2020. Individuals • The Medicare levy will be increased from 2.0% to 2.5% of taxable income from 1 July 2019. Other tax rates that are linked to the top personal tax rate, such as the fringe benefits tax rate, will also be increased. • The Medicare levy low-income thresholds for singles, families, and seniors and pensioners will increase from the 2016/17 income year. • A new set of repayment thresholds and rates under the higher education loan program (HELP) will be introduced from 1 July 2018. Social security • Residency requirements will be revised for the age pension and disability support pension (DSP). From

1 July 2018, claimants will generally need to have 15 years of continuous Australian residence before being eligible to receive the age pension or DSP unless certain exemptions apply. • From 20 September 2018, the maximum liquid assets waiting period will be increased from 13 weeks to 26 weeks. • The government will make a one-off energy assistance payment of $75 for single and $125 per couple for those eligible for qualifying payments on 20 June 2017. Qualifying payments include the age pension, DSP, parenting payment single, veterans’ service pension, veterans’ income support supplement, veterans’ disability payments, war widow(er)s pension. Other tax changes • The foreign investment framework will be clarified and simplified with effect from 1 July 2017. • A major bank levy will be introduced for authorised deposit taking institutions (ADIs), with licensed entity liabilities of at least $100b, from 1 July 2017. • Businesses that employ foreign workers on certain skilled visas will be required to pay a levy that will provide revenue for a new Skilling Australians Fund from March 2018. • The taxation of roll your own (RYO) tobacco and other products (eg cigars) will be adjusted so that manufactured cigarettes and RYO tobacco cigarettes receive comparable tax treatment. • The government will provide additional funding to Treasury and the Office of Parliamentary Counsel to ensure dedicated drafting resources for relevant legislation.

¶23-070 2018 Federal Budget Mr Scott Morrison, the Federal Treasurer, handed down his third Budget at 7.30 pm (AEST) on 8 May 2018. Mr Morrison said the Budget is focused on further strengthening the economy to “guarantee the essentials Australians rely on” and “responsibly repair the budget”. With a deficit of $18.2b in 2017/18 and $14.5b in 2018/19, the Budget is forecast to return to a balance of $2.2b in 2019/20 and a projected surplus of $11b in 2020/21. The government is proposing a three-step, seven-year plan to make personal income tax “lower, fairer and simpler”. The Budget also contains additional measures to counter the black economy, particularly in response to the final report from the Black Economy Taskforce, including expanding the taxable payments reporting system. Additionally, the Budget contains a range of measures intended to ensure the integrity of the tax and superannuation system. Click on the link to see the full version of the CCH Federal Budget Report. The full Budget papers are available at www.budget.gov.au and the Treasury ministers’ media releases are available at ministers.treasury.gov.au. The tax, superannuation and social security highlights are set out below. Individuals • A seven-year Personal Income Tax Plan will be implemented in three steps, to introduce a low and middle income tax offset, to provide relief from bracket creep and to remove the 37% personal income tax bracket. • The Medicare levy low-income thresholds for singles, families, seniors and pensioners will be increased from the 2017/18 income year. • The 2017/18 Federal Budget measure to increase the Medicare levy from 2% to 2.5% of taxable income from 1 July 2019 will not proceed. • Supplementary amounts (such as pension supplement, rent assistance and remote area allowance) paid to a veteran, and full payments (including the supplementary component) made to the spouse or partner of a veteran who dies are exempt from income tax from 1 May 2018. • Schemes to license a person’s fame or image to another entity such as a related company or trust to avoid income tax will be curtailed.

• The ATO will be provided with $130.8m from 1 July 2018 to increase compliance activities targeting individual taxpayers and their tax agents. Income tax • Significant changes to the calculation of the R&D tax incentive will commence for income years beginning on or after 1 July 2018. Additionally, a maximum cash refund will also apply for some entities. • The $20,000 instant asset write-off will be extended for small businesses by another year to 30 June 2019. • Amendments to Div 7A will strengthen the unpaid present entitlements (UPE) rules from 1 July 2019. • The start date of targeted amendments to Div 7A will be deferred from 1 July 2018 to 1 July 2019. • Deductions for expenses associated with holding vacant land not genuinely used to earn assessable income will be denied. • The small business capital gains tax (CGT) concessions will not apply to partners alienating rights to future partnership income. • Payments to employees and contractors are no longer deductible where any amounts that are required to be withheld are not paid, from 1 July 2019. • The definition of a “significant global entity” (SGE) will be broadened to include more large multinational groups, from 1 July 2018. • The thin capitalisation rules will be amended, effective 1 July 2019, to require entities to align the value of their assets for thin capitalisation purposes with the value included in their financial statements. • The thin capitalisation rules will be amended, effective 1 July 2019, to treat certain consolidated groups and multiple entry consolidated groups as both outward and inward investment vehicles for thin capitalisation purposes. • Tax exempt entities that become taxable after 8 May 2018 will not be able to claim tax deductions that arise on the repayment of the principal of a concessional loan. • The 50% capital gains discount for managed investment trusts (MITs) and attribution MITs (AMITs) will be removed at the trust level. • A specific anti-avoidance rule that applies to closely held trusts engaging in circular trust distributions will be extended to family trusts. • The concessional tax rates for the income of minors from testamentary trusts will not be available for trust assets unrelated to the deceased estate. • A five-year income tax exemption will be provided to a subsidiary of the International Cricket Council (ICC) for the ICC World Twenty20 to be held in Australia in 2020. • The list of countries whose residents are eligible to access a reduced withholding tax rate of 15% on certain distributions from Australian managed investment trusts (MITs) will be updated. • Six more organisations have been approved as specifically-listed deductible gift recipients. Superannuation • The maximum number of allowable members in SMSFs and small APRA funds will be increased to six from 1 July 2019. • The annual audit requirement for self managed superannuation funds will be changed to a three-yearly requirement for funds with a history of good record keeping and compliance. • Individuals whose income exceeds $263,157, and have multiple employers, will be able to nominate that their wages from certain employers are not subject to the superannuation guarantee (SG) from 1 July 2018. • Individuals will be required to confirm in their income tax returns that they have complied with “notice of intent” requirements in relation to their personal superannuation contributions, effective from 1 July 2018.

• An exemption from the work test for voluntary contributions to superannuation will be introduced from 1 July 2019 for people aged 65–74 with superannuation balances below $300,000, in the first year that they do not meet the work test requirements. • Insurance arrangements for certain superannuation members will be changed from being a default framework to being offered on an opt-in basis. • A 3% annual cap will be introduced on passive fees charged by superannuation funds on accounts with balances below $6,000, and exit fees on all superannuation accounts will be banned. • The financial institutions supervisory levies will be increased to raise additional revenue of $31.9m over four years, from 2018/19. Social security • The Pension Work Bonus (Work Bonus) will be increased to $300 per fortnight (up from $250 per fortnight) and for the first time it will also be extended to the self-employed. • Eligibility of the pension loans scheme (PLS) will be expanded to all individuals of age pension age and the maximum allowable combined age pension and PLS income stream will be increased to 150% of the age pension rate from 1 July 2019. • New age pension means testing rules will be introduced for pooled lifetime income streams from 1 July 2019. The rules will assess a fixed 60% of all pooled lifetime product payments as income, and 60% of the purchase price of the product as assets until 84, or a minimum of five years, and then 30% for the rest of the person’s life. Aged care • An additional 14,000 high level home care packages will be made available. Black economy measures • A package to reform the corporations and tax laws to deter and disrupt illegal phoenix activity and the black economy will be introduced. • The taxable payments reporting system for payments to contractors will be expanded to include security services, road freight transport and computer system design industries, effective from 1 July 2019. • Business seeking to tender for Australian Government contracts above $4m (including GST) will need to provide a statement of compliance with their tax obligations, from 1 July 2019. • Businesses can no longer receive cash payments above $10,000 for goods and services, from 1 July 2019.

INDEX A Accelerated depreciation

¶1-330

Acceptance of contributions work test exemptions

¶4-205

Account-based income streams

¶16-190

COVID-19 crisis

¶16-190

retirement incomes — strategies to maximise social security Account-based pensions (ABPs) advantages and disadvantages

¶16-130; ¶16-145 ¶16-620 ¶16-145; ¶16-500 ¶16-540

assessment — assets test

¶16-591

— income test

¶16-591

comparison of income streams

¶16-195

estate planning

¶19-110

impact of commutations

¶16-520

income limits

¶16-510

income tax — pension payments

¶4-320

income test strategies

¶6-840

minimum and maximum pension valuation factors

¶20-240; ¶20-260

non-commutable income streams

¶15-110; ¶16-585

Accumulation funds

¶4-110

Acquisition main residence

¶12-000

— exemptions

¶12-120

— financing

¶12-110

— structuring

¶12-100

Active assets

¶2-300; ¶2-310; ¶2-320

disposal of assets

¶1-295

50% exemptions

¶2-337

Add-backs financial and estate planning on family breakdown — property settlement — identification of property pool Administrative Appeals Tribunal (AAT) Administrative penalty tax Advanced investing

¶18-105 ¶3-420 ¶1-750–1-760 ¶21-800; ¶21-810

Adviser — see also Financial advisers tax deductibility of income protection insurance premiums

¶8-310

Advisory services guide (ASG)

¶8-300

AFS licensees

¶8-155

Age Pension

¶6-140

access by self managed superannuation fund

¶5-040

economic support payments to COVID-19

¶6-050

— first and second payment

¶6-140

energy supplement

¶6-140

exemptions

¶6-135

pension supplement

¶6-140

transitional arrangements

¶6-140

trusts Work Bonus Age Pension age Age Service Pension Aged care accommodation options for ageing clients

¶19-275 ¶6-140 ¶14-220; ¶15-005; ¶15-192 ¶6-420 ¶17-000; ¶20-580 ¶17-020

aged care fees — basic daily care fee

¶17-340

— Centrelink/DVA assessment of former home

¶17-340

— extra service fees

¶17-340

— means tested care fee

¶17-340

— Services Australia/DVA

¶17-340

downsizing — social security financial advice, value of

¶17-025

— entering residential care

¶17-015

— steps prior to residential care

¶17-015

granny flat interests — establishment of

¶17-030

— granny flat arrangement

¶17-030

— social security means-test assessment of

¶17-030

— value of, determined

¶17-030

home care — Commonwealth Home Support Programme (CHSP)

¶17-110

— home care packages (HCP)

¶17-120

— receiving services and support

¶17-100

independent living arrangements — independent living units — retirement villages

¶17-230 ¶17-200; ¶17-210

— Supported Residential Services (SRS)

¶17-220

quality of lifestyle

¶15-010

residential aged care — ACAT assessment — costs, calculating

¶17-320 ¶17-340; ¶20-580

— entering care

¶17-330

— entry process

¶17-310

— facilities

¶17-300

— facilities, changing

¶17-360

— family home and

¶17-350

— financial hardship assistance for

¶17-380

— respite care

¶17-370

retirement income

¶16-590

— account-based pension

¶16-591

— deductible amount rules

¶16-598

— fixed term income stream

¶16-592

— lifetime income stream

¶16-593

— strategies to minimise aged care fees

¶16-630

— term allocated pension

¶16-596

retirement living

¶17-010

retirement period

¶15-005

retirement villages — social security assessment and costs of

¶17-200; ¶17-210 ¶17-240

rates

¶20-580

schedule

¶20-580

Aged care services short life expectancy periods

¶16-630

Agricultural projects

¶9-360

Airline transport fringe benefits

¶3-200

Alienation of personal services income

¶1-265

All Ordinaries

¶9-260

Allowance rates JobSeeker Payment

¶20-450

Partner/Sickness Allowance

¶20-450

Allowances — see also Social security benefits assets test basic income test income test maximum benefit entitlement

¶6-520 ¶20-540 ¶6-540 ¶20-470

AML/CTF Program anti-money laundering and financing of terrorism

¶8-370

Annual or long service leave payments — see Unused leave entitlements Annuities — see also Income streams deceased estates

¶19-665

Life Expectancy Table

¶20-250

relationship breakdown — splitting of superannuation interests Anti-avoidance provisions acquisition of assets

¶4-480 ¶1-600–1-615 ¶5-350

family breakdown

¶18-515

general provisions

¶1-610

in-house assets

¶5-330

specific provisions

¶1-605

Anti-hawking

¶8-420

Anti-money laundering

¶8-370

Anti-spamming laws

¶8-425

Approved deposit funds (ADFs) — see also Superannuation entities death benefits, tax rules

¶19-610

definition

¶4-120

income tax

¶4-300

— rates

¶20-060

Arm's length investments self managed superannuation funds

¶5-380

Asian securities online investing

¶21-740

Assessable income

¶1-705

capital gains tax

¶1-295

complying superannuation funds

¶4-320

deductions — see Deductions derivation of income

¶1-250

employee share acquisition schemes

¶1-265

employment termination payments (ETPs)

¶1-285

foreign exchange gains

¶1-275

fringe benefits — living-away-from-home allowance fringe benefits

¶3-450

futures profits

¶1-275

investment income

¶1-270

life assurance

¶1-275

ordinary income

¶1-255

partnerships

¶1-280

pensions

¶1-265

personal services income

¶1-265

profit-making sale — property

¶1-275

— securities

¶1-275

small business entities

¶1-283

statutory income

¶1-255

superannuation — income streams

¶1-290

— lump sums

¶1-285

trust income

¶1-280

trusts

¶1-280

unused leave payments

¶1-265

Assessments amendment

¶1-705

objection or appeal

¶1-710

— deceased estate

¶19-900

retirement incomes — starting an income stream — assessment against the transfer balance cap tax assessments

¶16-155 ¶1-705

Asset allocation direct property investment

¶9-316

Strategic asset allocation (SAA)

¶9-380

Tactical asset allocation (TAA)

¶9-380

Asset concentration

¶5-000

Assets register, CGT records

¶2-530

Assets test — see Income and assets test Assets test assessment account-based pension (ABP)

¶16-591

term allocated pension (TAP)

¶16-596

Assets waste financial and estate planning on family breakdown — property settlement — identification of property pool

¶18-105

Associated persons non-fringe benefit payments

¶3-600

partnership payments

¶1-455

Association of Financial Advisers (AFA)

¶8-155

Association of Superannuation Funds of Australia (ASFA)

¶7-998

At call money investments

¶9-110

Attribution managed investment trusts (AMITs) CGT tax

¶2-215

proposed changes

¶2-250

Australian Bureau of Statistics (ABS)

¶7-075

Australian Business Number (ABN)

¶1-120

self managed superannuation funds

¶5-100

Australian Competition and Consumer Commission (ACCC) restrictive trade practices

¶8-405; ¶8-415

Australian Consumer Law (ACL) consumer protection — fair trading

¶8-410

— misleading and deceptive conduct

¶8-405

— restrictive trade practices, unfair contracts

¶8-415

Australian Credit License

¶8-410

Australian equity trusts

¶9-520

Australian films

¶9-360

Australian Financial Complaints Authority (AFCA) Australian Financial Services Licence (AFSL)

¶4-150; ¶8-010; ¶8-615; ¶19-095 ¶8-250; ¶8-420

compliance

¶8-010

key reporting obligations

¶8-020

Australian fixed interest trusts

¶9-480

Australian Institute of Health and Welfare (AIHW)

¶7-075

Australian Institute of Superannuation Trustees (AIST)

¶7-998

Australian Privacy Principles (APPs)

¶8-510

Australian property trusts

¶9-500

Australian Prudential Regulation Authority (APRA)

¶8-010

changes to income protection

¶7-345

mean life insurance providers

¶7-320

superannuation regulation

¶4-150

Australian Scholarships Group (ASG) annual schooling costs of children

¶13-305

Australian Securities and Investments Commission (ASIC)

¶8-010

advice fees to superannuation members

¶8-155

approach to enforcement

¶8-020

approach to FOFA implementation

¶8-020

ASIC-approved compliance scheme

¶8-265

breach reporting

¶8-010

Code of Conduct

¶8-155

complaints handling — external dispute resolution — remediation and advice review programs consumer protection Consultation Paper (CP)

¶8-615 ¶8-405; ¶8-410 ¶8-320

financial advisers — conflicts of interest

¶8-150

FPA Code

¶8-155

FSG exemption for secondary service providers

¶8-300

investment performance

¶8-125

penalties for breaches

¶8-420

pre-FOFA sample SoAs

¶8-310

Regulatory Guide (RG)

¶8-020; ¶8-420

scaled and single-issue advice

¶8-310

Statement of Advice presentation

¶8-310

Superannuation Complaints Tribunal

¶4-150

training of financial product advisers

¶8-260

Australian Securities and Investments Commission (ASIC) Regulatory Guides compliance

¶8-010; ¶8-420

Australian share market — see Domestic equities Australian superannuation funds

¶4-600

Australian Taxation Office (ATO)

¶5-320; ¶8-010

advice under development

¶2-650

choice penalty

¶4-580

cryptocurrency

¶9-375

deductibility of particular types of expenses

¶3-500

employers affected by COVID-19

¶4-560

flexible, reasonable and pragmatic approach

¶4-510

home loan unit trust schemes

¶12-100

parent’s company — for reasons of natural love and affection registered religious institution service days and days to retirement

¶18-510 ¶3-650 ¶14-330

Services Australia

¶6-050

superannuation — contributions made to a fund

¶4-203

superannuation regulation

¶4-150

Australian Transaction Reports and Analysis Centre (AUSTRAC)

¶8-010

KYC requirements during the COVID-19

¶8-370

Australia's Future Tax System Review

¶16-115

Austudy

¶6-050; ¶6-250

COVID-19 temporary measures

¶6-250

NARWP

¶6-750

Automatic insurance covers Key Facts Sheet

¶7-998

Avoidance of tax — see Tax avoidance Avoidance schemes CGT

¶2-520

B Bad debts deductions

¶1-305

Balanced trusts

¶9-540

Balancing adjustments depreciating assets

¶1-330

— CGT cost base

¶2-205

— CGT events

¶2-110

— compulsory acquisition

¶2-410

Bankruptcy capital gains and losses Family Court powers HELP debts

¶2-110; ¶2-220 ¶18-820 ¶13-410; ¶13-415

pre-bankruptcy superannuation contributions

¶4-160

self managed superannuation fund protection

¶5-040

Beneficiaries assessable income

¶1-280

assets appropriated by trustee

¶19-670

CGT

¶1-295

— absolute entitlement

¶2-220

— artificially creating capital losses through default beneficiary arrangement

¶2-650

— deceased estates

¶19-150

— “specifically entitled”

¶2-360

— trust provisions

¶2-360

children — deceased estates — income tax

¶19-505; ¶19-510; ¶19-750 ¶1-070

— tax rates on trust income

¶19-855

contesting will

¶19-090

Cultural Bequests Program

¶19-760

death benefits — see Death benefits deceased estates — acquisition of dwellings

¶19-605

— adjusting entitlements

¶19-115

— asset sold to beneficiary

¶19-680

— CGT

¶19-150

disclaimed interests

¶19-715

discretionary life interest

¶19-075

discretionary will trusts

¶19-200–19-275

estate proceeds trusts

¶19-410

extra capital gain

¶2-360

fixed life interest

¶19-070

intestate estate

¶19-515

legal disability

¶1-515

— restricted trusts

¶19-300

life insurance

¶19-370

presently entitled

¶1-510; ¶19-850

— tax rates on trust income

¶19-855

public galleries, museums and libraries

¶19-760

restricted trusts

¶19-300–19-315

special disability trusts

¶19-300

spendthrift beneficiary

¶19-300

superannuation death benefits

¶19-365

— binding death benefit nomination

¶19-365

— child account-based pensions

¶16-930

— tax rules

¶19-610

superannuation funds bequest

¶19-755

superannuation proceeds trusts

¶19-405

testamentary gifts

¶19-060

— specific items

¶19-065

trust income trusts, CGT rules will drafting

¶1-505–1-520 ¶2-360 ¶19-030

Benefit periods business expenses insurance

¶7-610

income protection

¶7-340

Bereavement Payments

¶6-290; ¶19-960

Best interest duty achieving safe harbour

¶8-120

Best practice

¶8-100

financial advisers — appropriate advice

¶8-125

— best interest duty

¶8-120

— competencies, experience and training

¶8-170

— conflicts of interest

¶8-150

— disclosure to clients — efficiently, honestly and fairly — Future of Financial Advice (FOFA) reforms

¶8-290–8-320 ¶8-140 ¶8-020; ¶8-120

— key elements

¶8-110

— “know-your-client, know-your-product” rule

¶8-130

— “know-your-client” rule

¶8-120

— professional codes and standards

¶8-190

— quality advice

¶8-130

— remuneration and disclosure

¶8-155

— standards requirements

¶8-120

— supervision

¶8-180

Better Trust

¶2-360

Blended families estate planning

¶18-830

Board fringe benefits

¶3-200

Bonds

¶9-160

pricing differentials

¶9-180

yield curve

¶9-170

Bonus shares CGT cost base death of shareholders

¶2-205 ¶19-620

Borrowing deductions for investors and landlords geared share managed funds gearing investments

¶1-325 ¶11-600 ¶11-200–11-550

— diversified funds

¶11-260

— fixed interest investments

¶11-450

— projections

¶11-550

— superannuation funds

¶11-520

partnerships self managed superannuation funds Bring-forward rule age-based restrictions

¶1-450–1-465 ¶5-330; ¶5-360 ¶5-350; ¶15-048 ¶17-025

Brokers — see Online brokers Budget Federal Budget — see Federal Budget financial planning for family — budget planning

¶13-060

— cost of raising children

¶13-070

— goal setting

¶13-050

life and personal risk insurance — level premiums

¶7-910

retirement planning

¶15-540

Budget repair levy superannuation income streams Temporary Budget Repair Levy (TBRL)

¶1-290

— estate planning and consequences of death — income tax savings

¶19-255

— income streams from non-complying Australian funds

¶16-810

— salary packaging

¶10-060; ¶10-200; ¶10-340; ¶10620

Budgeting

¶13-050

family budget planning

¶13-060

Buildings — see also Income producing property CGT rule

¶2-350

Business cycle online tracking

¶21-600

— monitoring economy

¶21-610

— monitoring international economy

¶21-620

— sector rotation

¶21-630

Business enterprises

¶2-110

Business income deductible and non-deductible expenses

¶1-310

Business real property SMSF investment Business succession

¶5-350; ¶5-500 ¶19-800

effect of death — depreciable plants and buildings

¶19-810

— trading stocks

¶19-805

planning

¶7-700

— components of buy/sell plan

¶7-710

— structuring buy/sell insurance

¶7-720

— tax implications for buy/sell arrangements

¶7-760

C Calculation methodology expenses method

¶7-520

replacement method

¶7-520

Call and put options

¶9-335

CGT rules

¶2-355

Capital allowances

¶1-340

Capital gain or losses CGT — artificially creating capital losses through default beneficiary arrangement — calculation

¶2-650 ¶2-210; ¶2-500

— capital proceeds rules

¶2-208

— cost base calculation

¶2-200

— cost base modifications and special rules

¶2-205

— deferring

¶2-400

— discount capital gains and discount percentage

¶2-215

— re-characterising capital losses as revenue losses

¶2-650

— superannuation funds

¶4-320

Capital gains remaining after streaming specific entitlements

¶2-360

“specifically entitled” beneficiary

¶2-360

Capital gains tax (CGT)

¶1-295; ¶2-000; ¶2-050

assets passing on death

¶1-295

bankruptcy

¶2-220

business succession — effect of death on trading stock

¶19-805

capital gain or losses — see Capital gain or losses CGT rules CGT trap on retirement

¶2-050 ¶11-500

checklists — CGT planning

¶2-600

— CGT topical

¶2-700

— taxpayer alerts

¶2-650

children's trust income complying superannuation funds

¶13-620 ¶4-320

deceased estates

¶19-150

— asset sold to beneficiary

¶19-680

— assets appropriated by trustee for beneficiary

¶19-670

— assets subsequently acquired

¶19-675

— bequest to superannuation

¶19-755

— capital improvement

¶19-690

— charitable gift

¶2-110; ¶19-755

— disclaimer by beneficiary — disposal of assets

¶19-715 ¶2-110; ¶19-550; ¶19-555

— dwellings

¶19-605

— exempt bequests

¶19-760

— gifts to tax-deductible organisations

¶19-160

— gifts to tax-exempt organisations

¶19-160

— joint tenancy

¶19-695

— motor vehicles

¶19-635

— non-resident beneficiary

¶19-765

— option to acquire asset

¶19-685

— personal use assets and collectables

¶19-630

— shares

¶19-620

— testamentary gifts

¶19-160

discount percentage for particular taxpayers

¶2-217

discretionary life interest

¶19-075

discretionary will trusts

¶19-265

exemptions, concessions and special rules

¶2-250

— basic and additional basic conditions

¶2-310

— exempt assets, proceeds and transactions

¶2-270

— 15-year asset exemption

¶2-336

— 50% active asset exemption

¶2-337

— foreign and temporary residents

¶2-280

— look-through tax treatment for instalment trusts

¶2-250

— options

¶2-355

— other exemptions or loss-denying transactions

¶2-343

— personal use assets and collectables

¶2-340

— pre-CGT assets

¶2-260

— separate asset rule

¶2-350

— significant individual test

¶2-323

— small business CGT concessions

¶1-295; ¶2-300

— small business replacement asset roll-over

¶2-339

— small business retirement exemption

¶2-338

— special disability trusts (SDTs)

¶2-250

— special rules for trustees and beneficiaries of a trust

¶2-360

— start-up investments

¶2-250

family breakdown — investment properties

¶18-500

— main residence

¶12-200–12-215

— property pool, identification

¶18-105

— realisation and taxation costs

¶18-300

— roll-over relief

¶18-505

— share transfers

¶18-505

— superannuation splitting

¶4-480

foreign resident beneficiary exemption

¶2-360

foreign resident exemption — foreign trusts and beneficiaries main residence exemption

¶2-360 ¶1-295; ¶12-050; ¶12-053; ¶12580

— absences from main residence

¶12-640

— adjacent land sold separately

¶12-670

— changing main residences

¶12-630

— delay in moving

¶12-620

— destruction of dwelling and sale of land

¶12-650

— disposal

¶12-052

— dwelling

¶12-053

— dwelling constructed on vacant land

¶12-120

— dwelling originally used as main residence

¶12-600

— estate planning

¶19-155

— family breakdown

¶12-200–12-215

— family home

¶12-580

— home office

¶12-056

— income-producing use

¶12-056

— non-main residence days

¶12-590

— person ceasing to be Australian resident

¶12-051

— spouse/child separate dwelling

¶12-680

non-resident CGT withholding

¶1-295

other CGT concessions and rules — managed investment trusts

¶2-250

rates

¶20-150

— index numbers

¶20-160

rental property — taxation implications of Airbnb

¶12-350

retirement planning — small business and superannuation

¶15-200

— small business retirement issues

¶15-210

roll-overs — see Roll-overs special disability trusts (SDTs)

¶2-250

tax calculation — net capital gains and losses

¶2-500

— overlap with other tax rules and avoidance schemes

¶2-520

— records keeping

¶2-530

taxpayer alerts — artificially creating capital losses through default beneficiary arrangement

¶2-650

— avoidance using a trust structure

¶2-650

— re-characterising capital losses as revenue losses

¶2-650

transactions covered — CGT assets

¶2-100

— CGT events

¶2-100; ¶2-110

withholding tax

¶12-070; ¶12-071

— clearance certificate

¶12-072

Capital improvements CGT rules — deceased estates

¶2-350 ¶19-690

Capital proceeds CGT events — general rule Capital Protected Borrowings (CPBs)

¶2-208 ¶11-420

Capital stable trusts

¶9-540

Capital works expenditure

¶1-335

Capped defined benefit income streams retirement incomes — transfer balance cap and starting an income stream

¶16-180

Car expense fringe benefits

¶3-200; ¶3-600

Car fringe benefits

¶3-200; ¶3-410

rates of tax

¶20-210; ¶20-220

Car parking

¶3-650

commercial parking station

¶3-420

fringe benefits

¶3-200; ¶3-420

and remote area concessions

¶10-320

salary packaging

¶10-320

Carer Allowance

¶6-135

economic support payments due to COVID-19

¶6-170

Carer Payments

¶6-160

economic support payments due to COVID-19 Carers Supplement

¶6-050; ¶6-160 ¶6-160

Cars (motor vehicles) associate leases CGT-exempt

¶10-310 ¶2-270

— deceased estates

¶19-635

depreciation limits

¶10-310

high business use

¶10-310

no business use

¶10-310

novated leases

¶10-310

salary packaging

¶10-310

Case studies salary packaging

¶10-700–10-740

Cash flow boost subsidy to employers during COVID-19

¶1-260

Cash Management Account (CMA)

¶9-470

Cash management trusts (CMT) Cashing of superannuation benefits

¶8-300; ¶9-470 ¶15-400

Centrelink benefits — see also Social security benefits Grandparent Child Care Subsidy

¶13-735

Centrelink pension overseas proof of life certificate for 80+ year olds living overseas

¶6-050

Centrelink/Veterans’ Affairs (DVA) deductible rules lifetime income streams assessment CGT assets general modification rules for cost base

¶16-593 ¶2-100

— apportionment

¶2-205

— assumption of liability

¶2-205

— look-through earnout rights

¶2-205

— market value substitution

¶2-205

— put options

¶2-205

— split, changed or merged assets

¶2-205

indexation factor

¶2-200

know-how

¶2-100

net input tax credit

¶2-200

reduced cost base

¶2-200

CGT discount additional discount for qualifying affordable housing

¶2-217

CGT discount percentage

¶2-210; ¶2-217

CGT events

¶2-100; ¶2-110

capital proceeds rules

¶2-208

Everett assignments

¶2-310

foreign resident beneficiary exemption

¶2-360

CGT regime

¶2-050

Charitable gifts deceased estates — CGT

¶19-755 ¶2-110

— testamentary gifts

¶19-160

deductible donations

¶1-345

Charting online facilities

¶21-260

online tools

¶21-310

Checklists CGT

¶2-110; ¶2-600–2-700

financial advisers best practice principles

¶8-110

financial services

¶8-230

gearing general obligations of licensees redundancy Child account-based pensions

¶11-150 ¶8-280 ¶14-120

death benefits

¶16-930

Child care — see also In-house child care family financial planning

¶13-200

— child care costs

¶13-205

— child care options

¶13-200

— Child Care Subsidy

¶13-730

— employer-provided child care

¶13-200

Child care benefit (CCB) Child Care Subsidy

¶13-730

income test

¶13-725

Child Care Subsidy (CCS)

¶13-730

care provers

¶13-730

Grandparent Child Care Subsidy

¶13-735

immunisation and residency requirements

¶13-730

Child maintenance — see Child support Child pension modified transfer balance cap rules

¶19-405

parent’s transfer balance cap

¶19-405

Child support

¶13-800

adult child maintenance

¶18-710

child maintenance trusts

¶13-810; ¶18-715

family breakdown — family financial planning

¶18-705 ¶13-800–13-810

child support scheme — child support agreements

¶13-805

— child support and impact on family tax benefit

¶13-805

— child support assessments

¶13-805

— child support ordered by the court

¶13-805

— income for child support assessments

¶13-805

Child support payments and services

¶4-215

Services Australia

¶6-050

Children appointment of guardians beneficiaries

¶19-055

— adjustment to entitlements — deceased estates — discretionary will trusts

¶19-115 ¶19-505; ¶19-510; ¶19-750 ¶19-255

— income tax

¶1-070

— legal disability

¶1-515

— testamentary trust income child pension

¶19-855 ¶19-405; ¶19-610

family breakdown — see Child support family financial planning — child care

¶13-200

— child support

¶13-800

— children's savings options

¶13-500

— estate planning

¶13-900

— government assistance

¶13-700

— investing for education

¶13-300–13-420

— raising cost — taxation of income

¶13-070 ¶13-600–13-625

income tax — discretionary will trusts — unearned income

¶19-255 ¶1-070

savings — options

¶13-500

— special disability trusts

¶13-510

— teaching children the value of money

¶13-505

self managed superannuation funds taxation of children's income

¶5-020 ¶13-600

Choice of fund rules penalties for failing to comply

¶4-580

Choice of superannuation fund rules superannuation guarantee contributions

¶4-580

Claims process insurance policy waiting periods

¶7-975

investigation

¶7-970

lodging

¶7-960

performance, distinction

¶7-978

surveillance

¶7-970

verification

¶7-965

Class Rulings

¶1-650

Client service agreement (CSA)

¶8-155

Clothing, deductible expenses

¶1-320

Co-contributions — see Government co-contributions Code monitoring Code of ethics

¶8-265 ¶8-000; ¶8-265

Collectables CGT — deceased estates

¶2-110; ¶2-340 ¶19-630

— topical checklist

¶2-700

investment

¶9-365

Collection of tax

¶1-105

Commercial parking station

¶3-420

Commission financial advice — annual renewal and payment

¶8-020

— disclosure of lack of independence

¶8-020

— grandfathered commissions

¶8-020

— life risk insurance commissions

¶8-020

— misconduct by financial advisers

¶8-020

— new disciplinary system

¶8-020

— reference checking and information sharing

¶8-020

— reporting compliance concerns

¶8-020

— review of measures to improve the quality of advice

¶8-020

Commission, executors

¶19-050

Commissioner may make a determination to disregard contributions

¶4-250

Commodities investments online investing Commonwealth Home Support Programme (CHSP)

¶9-330 ¶21-440

assessment and access

¶17-110

cost of

¶17-110

and home care packages (HCP)

¶17-110

services available

¶17-110

Commonwealth Seniors Health Card (CSHC)

¶6-360

economic response to COVID-19

¶6-050

Community Bank company

¶2-110

Commutation of death benefit income stream

¶16-920; ¶16-940

Commutation of income streams account-based pensions

¶16-520

complying income streams — impact of commutations

¶16-840

income tax

¶16-780

— pre-1 July 2007

¶16-760

Companies acquisition of family home

¶12-100

announcements — websites

¶21-220

CGT non-assessable payments

¶2-205

direct value shifts

¶2-110

family breakdown — see Family companies shares — CGT options

¶2-355

tax

¶1-400

— debt and equity interests

¶1-400

— financial and income year

¶1-100

— gross tax

¶1-055

— imputation system

¶1-405

— losses

¶1-400

— rates

¶20-070

— removal of tax preferences

¶1-405

— residency tests

¶1-550

taxation offences of company officers

¶1-760

Compensation CGT-exempt

¶2-270

social security benefits, preclusion period

¶6-710

Compensation scheme of last resort (CSLR)

¶8-020

Competition and Consumer Act 2010 — see Australian Consumer Law (ACL) Complaint, defined

¶8-610

Complaints process life insurance

¶7-980

— complaints for insurance inside superannuation

¶7-985

Complaints resolution scheme financial advisers

¶8-600–8-615

superannuation entities

¶4-150

Compliance

¶8-000

breaches

¶8-010

definition

¶8-010

framework of compliance

¶8-010

key reporting obligations

¶8-020

legislative framework

¶8-020

— common law obligations

¶8-020

Complying income streams commuting complying income streams

¶16-840

criteria

¶16-830

Complying superannuation funds — see Superannuation funds Compulsory SG contributions salary sacrificed superannuation contributions

¶10-040

Computers salary packaging Concession cards

¶10-520 ¶6-360; ¶6-480

Concessional contributions excess contributions

¶15-050

personal deductible

¶15-050

retirement planning

¶15-050

— annual concessional cap

¶15-050

superannuation — tax on high income earners proposed

¶4-200 ¶4-225; ¶15-050

Concessional rebates

¶1-355

Concessional tax — see Tax concessions Conflicts of interest

¶8-150

financial advisers — disclosure to clients

¶8-290–8-320

Consolidation regime CGT events

¶2-110

company tax

¶1-400

trusts

¶1-505

Consumer Directed Care Packages (CDC)

¶17-240

Consumer Price Index (CPI) transfer balance cap

¶4-229

Consumer protection Corporations Act 2001

¶8-420

fair trading

¶8-410

financial services

¶8-400

misleading and deceptive conduct

¶8-405

other laws

¶8-425

penalties for breaches of corporate laws

¶8-420

restrictive trade practices

¶8-415

Contingent gifts deceased estates Continuing professional development (CPD) Contract for difference (CFD)

¶19-660 ¶8-170 ¶9-335; ¶21-840

Contractors superannuation guarantee (SG) scheme

¶4-520

Contributions — see also Superannuation contributions acceptance — work test exemptions

¶4-205

shares and bonds

¶4-210

Contributions splitting Controlled foreign companies (CFCs)

¶4-260; ¶15-192

accruals taxation

¶1-570

resident tax

¶1-550

Convertible notes CGT cost base

¶2-205

Corporate limited partnerships

¶1-400

Corporate trustees self managed superannuation funds

¶5-020

Cost base CGT — calculation

¶2-200

— modifications and special rules

¶2-205

— modifications in roll-over of assets

¶2-205

general modification rules of CGT asset — apportionment

¶2-205

— assumption of liability

¶2-205

— look-through earnout rights

¶2-205

— market value substitution

¶2-205

— put options

¶2-205

— split, changed or merged assets

¶2-205

Cost base of asset, elements of

¶2-200

Cost base or reduced cost base expenditure excluded

¶2-200

Costs general rules

¶2-200

Counter-terrorism financing

¶8-370

COVID-19 account-based income streams adverse economic effects advice-related relief

¶16-190 ¶4-000; ¶4-400 ¶8-310

alternate dispute resolution

¶18-835

assets test for non-home owners

¶20-560

changes to reporting employment income delayed

¶6-050

complying with KYC requirements — AML/CTF program

¶8-370

— customer identification and verification

¶8-370

crisis analysts

¶11-550

Crisis Payment

¶6-050

economic impacts economic support payments to

¶6-520; ¶6-540; ¶6-640; ¶6-705; ¶6-720; ¶6-750; ¶8-020 ¶6-050; ¶6-140; ¶6-160; ¶6-170; ¶6-180

employers — cash flow boost subsidy

¶1-260

existing advisers, education standard exam

¶8-265

FASEA continuing professional development standard

¶8-265

income support payments

¶6-050

individual financially affected by

¶4-435

investment values

¶5-010

JobKeeper Payment

¶6-050; ¶6-190

JobSeeker Payment

¶6-190

margin calls and minimum income payment to clients mutual obligation requirements

¶11-350 ¶16-410; ¶16-585 ¶6-190; ¶6-240

ordinary waiting period

¶6-705

quarantine or self-isolation

¶6-050

removal of LAWP

¶14-430

self isolation

¶8-370

social distancing

¶8-265

state-sponsored lockdowns

¶8-265

Supplement

¶6-050; ¶6-190; ¶6-240; ¶6-250; ¶20-470

suspension of assets test

¶6-250

temporary changes due to

¶6-540

temporary changes to CCS

¶13-730

temporary early release

¶15-400

temporary measures temporary suspension of NARWP work-from-home during

¶6-240; ¶6-250 ¶6-185 ¶8-265; ¶12-060

Credit and Investments Ombudsman Service (CIO)

¶8-615

external dispute resolution

¶8-615

Credit cards FBT expense payment benefits

¶3-430

Crisis Payment

¶6-050; ¶6-190

Cross-border issues accruals taxation system

¶1-570

Australians investing overseas

¶1-565

foreign losses

¶1-580

resident v non-resident

¶1-550

source of income

¶1-555

thin capitalisation

¶1-560

Cryptocurrency

¶9-375

Cultural Bequests Program CGT exemption testamentary gifts Customer Advice Record (CAR)

¶2-270; ¶19-160 ¶1-345; ¶19-160; ¶19-760 ¶8-010

Currency trading online investing

¶21-430

D Daily Accommodation Payment (DAP)

¶17-340

De facto relationships family breakdown — domestic relationship agreements — Family Court

¶18-005; ¶18-015 ¶18-825 ¶18-010; ¶18-120

Death benefits — see also Superannuation benefits account-based pensions

¶16-500

death cover

¶7-860

dependant/non-dependant

¶4-425

fixed term income streams

¶16-200

income streams

¶16-900

— child account-based pensions

¶16-930

— commutation

¶16-920

— taxation

¶16-910

— transfer balance caps

¶16-940

lifetime income streams

— death benefit dependant self managed superannuation funds

¶16-330 ¶5-700; ¶16-900

superannuation funds — binding death benefit nominations — death benefits dependant — deductions

¶18-205; ¶18-830; ¶19-365 ¶19-610 ¶4-320

— estate planning

¶19-365

— family breakdown

¶18-830

— non-death benefits dependant

¶19-610

— tax rules

¶19-610

tax treatment

¶4-425

taxation of superannuation death benefits

¶20-305

termination payments

¶14-250

— tax treatment

¶1-285

unused long service leave payments

¶1-265

Debentures

¶9-150

investments

¶9-150

Debt management family financial planning

¶13-100

— myths and strategies

¶13-105

Debt markets online investing Debt waiver fringe benefits

¶21-420 ¶3-200; ¶3-440

Debt/equity ratio company tax

¶1-400

thin capitalisation

¶1-560

Deceased estates account-based pensions or annuities

¶19-110

accrued leave payments

¶19-625

administrator

¶19-515

annuities

¶19-665

asset acquired under option

¶19-685

asset distribution

¶19-500; ¶19-505

— contesting will

¶19-520

— dwellings

¶19-605

— executor/trustee

¶19-510

— intestacy

¶19-515

— tax on disposals

¶19-555

— tax rules

¶19-550; ¶19-600

asset sold to beneficiary

¶19-680

assets appropriated by trustee for beneficiary

¶19-670

assets subsequently acquired by trustee

¶19-675

bequest to superannuation funds

¶19-755

business succession

¶19-800–19-810

capital improvements

¶19-690

CGT — assets passing on death — charitable gifts

¶2-110; ¶19-150 ¶1-295 ¶2-110; ¶19-755

— charities and superannuation funds

¶19-755

— gifts to tax-exempt organisation

¶19-160

— small business concessions

¶19-610

— topical checklist

¶2-700

child beneficiary

¶19-750

— testamentary trusts

¶19-855

contingent gifts

¶19-660

cultural bequests

¶19-760

death and liability — duties

¶19-950

— land tax

¶19-955

— social security

¶19-960

disclaimed interests

¶19-715

discretionary trusts, tax rules

¶19-700

discretionary will trusts

¶19-200–19-275

executors

¶19-050

— asset distribution

¶19-505

— duties and powers

¶19-510

income and testamentary trusts

¶19-850

— tax rates

¶19-855

income tax — date-of-death return

¶19-900

— trust estate returns

¶19-905

intestacy

¶19-515

joint tenants, tax rules

¶19-695

legacies

¶19-655

life estates — tax rules

¶19-710

life insurance, tax rules

¶19-615

main residence

¶12-800

mortgaged property

¶19-705

motor vehicles

¶19-635

non-residents

¶19-765

overseas assets

¶19-505

personal use assets/collectables

¶19-630

shares, tax rules

¶19-620

small business CGT concessions superannuation death benefits, tax rules taxation of trusts — no beneficiary presently entitled testamentary trusts — discretionary will trusts — estate planning for children

¶2-300; ¶2-310; ¶2-350 ¶19-610 ¶1-500–1-525 ¶1-520 ¶13-915; ¶19-850; ¶19-855 ¶19-200–19-275 ¶13-915

trustee — appointment

¶19-505

— duties and powers

¶19-510

Deductible amount (before 1 July 2007) annuities or pensions

¶4-450

income streams

¶16-720

— relevant number

¶16-740

Deductible expenditure

¶2-200

Deductions annual basis of taxation

¶1-300

business expenses

¶1-310

capital allowances

¶1-340

capital works expenditure

¶1-335

car lease expenses

¶3-410

Commissioner’s guidelines for particular occupations

¶1-320

company tax losses

¶1-400

death benefit payments

— anti-detriment deduction

¶4-320

depreciating assets

¶1-330

disability insurance premiums

¶4-320

employment expenses

¶1-320

family trust losses

¶1-525

fringe benefits

¶3-150

— living-away-from-home allowance fringe benefits

¶3-450

— “otherwise deductible” rule

¶3-500

geared investments

¶11-200

— foreign investment

¶11-230

— interest on protected loans

¶11-420

— PAYG

¶11-270

— timing

¶11-220

general and specific

¶1-305

gifts and donations

¶1-345

home office expenses

¶12-060; ¶12-062

— occupancy costs

¶12-066

— place of business

¶12-065

— place of convenience

¶12-060; ¶12-062

— running costs

¶12-066

— work-related expenses

¶12-068

investors and landlords — financial advice fees

¶1-325

— interest

¶1-325

— losses on investments

¶1-325

— ongoing expenses

¶1-325

partnerships

¶1-455

rental income, main residence

¶12-300

— taxation implications of Airbnb

¶12-350

return paid on debt interest

¶1-400

self-employment expenses

¶1-320

superannuation contributions — concessional contributions

¶4-200; ¶4-225; ¶15-050; ¶20-310

— employer contributions

¶4-210

— employer contributions following salary sacrifice

¶4-215

— personal contributions

¶4-220

— personal deductible

¶15-050

tax-effective investments

¶9-360

tax losses

¶1-065

trust losses

¶1-525

Default assessments

¶1-705

deceased estates

¶19-900; ¶19-905

Defined benefit funds accrual of benefits

¶4-205

definition

¶4-110

family breakdown

¶18-205

Defined benefit income cap

¶4-420

Defined benefit members

¶4-225

Defined benefit schemes income and asset test income stream

¶6-640

Definitions account-based income streams

¶16-190

accumulation funds

¶4-110

advisers

¶8-010

any occupation

¶7-210

approved deposit funds (ADFs)

¶4-120

arrangements

¶3-100; ¶3-150

assessable income

¶1-000

assets

¶6-520

associates

¶3-100; ¶4-233

at call

¶9-110

Australian Financial Services Licence (AFSL)

¶8-250

Australian Prudential Regulation Authority (APRA)

¶7-080

Australian residents

¶1-550

average weekly ordinary time earnings

¶20-290

beneficiaries

¶7-080

benefit income streams

¶4-232

bonds

¶9-160

breach

¶8-010

business cycles

¶9-070

business real property

¶5-350

carrying on a business

¶2-320

cash

¶9-070

CGT assets

¶2-100

CGT events

¶2-100

CGT rules

¶2-050

commodities

¶9-330

compassionate benefits

¶15-400

compensation

¶6-710

compliance

¶8-010

complying superannuation funds

¶4-110

compound growth

¶15-015

compound interest

¶9-020

concessional contributions “connected with” another entity

¶4-200; ¶4-234 ¶2-315

death benefit termination payments

¶14-250

death benefits

¶19-610

debentures

¶9-150

deductions

¶1-000

defensive assets

¶9-070

defined benefit funds

¶4-110

dependants dividends

¶4-425; ¶19-610 ¶9-020

dwelling

¶12-053

early retirement schemes

¶14-210

earnout arrangements

¶2-345; ¶2-350

eligible roll-over fund (ERF)

¶4-120

employee contribution

¶3-550

employees employment-related activities estate planning Exchange traded funds (ETFs) financial hardship

¶4-210; ¶5-020 ¶4-220 ¶19-010 ¶9-535; ¶21-900 ¶15-400

financial product advice

¶8-230

financial products

¶8-220

Financial Services Guide (FSG)

¶8-300

financing of terrorism

¶8-370

fixed interest securities

¶9-110

foreign residents

¶2-280

friends fringe benefits

¶3-100 ¶3-100; ¶3-200

fringe benefits tax

¶3-050

geared investment

¶11-010

genuine redundancy

¶14-200

growth assets

¶9-070

in-house assets test

¶5-330

in-house residual fringe benefits

¶3-445

income

¶6-350; ¶6-540

income protection

¶7-300

income tax

¶1-000

inflation

¶9-070

informed consent

¶8-130

invalidity

¶14-300

investment timing and dollar cost averaging

¶9-020

“know your client”

¶8-120

“know your client, know your product”

¶8-130

lease or lease arrangements

¶5-330

life benefit termination payments

¶14-250

life insurance company

¶7-080

life insured

¶7-080

listed securities

¶5-350

money laundering

¶8-370

negative gearing

¶11-050

non-account based income streams

¶16-190

non-concessional contributions

¶4-240

occupancy costs

¶12-066

opportunity cost

¶9-070

own occupation

¶7-210

partnership

¶1-450

permanent incapacity

¶15-400

policy document

¶7-080

policy owner(s)

¶7-080

pooled lifetime income stream pooled superannuation trust (PST) prescribed non-residents Product Disclosure Statement (PDS)

¶16-593 ¶4-120 ¶20-030 ¶7-080; ¶8-320

public offer superannuation funds

¶4-110

public sector funds

¶4-110

re-insurers

¶7-080

Record of Advice (RoA)

¶8-315

registrable superannuation entity

¶4-150

related party

¶5-330

related trust

¶5-330

relatives

¶3-100; ¶5-020

replacement asset roll-over

¶2-410

reportable fringe benefits

¶3-155

retirement retirement savings accounts (RSAs)

¶15-400 ¶4-120

running costs

¶12-066

salary packaging

¶10-010

salary packaging arrangement

¶3-850

same asset roll-over

¶2-410

self managed superannuation funds

¶4-110; ¶5-020

short-term money markets

¶9-130

simple interest

¶9-020

small superannuation funds

¶4-110

spouse

¶4-275; ¶4-425

Statement of Advice (SoA)

¶8-310

suitability rule

¶8-130

superannuation benefits

¶4-210

superannuation funds

¶4-110

superannuation interest

¶4-480

tax payable

¶1-000

temporary incapacity

¶15-400

temporary residents

¶2-280

term deposits

¶9-140

terminal illness testamentary trust

¶15-400 ¶19-165; ¶19-850

total and permanent disability (TPD) insurance

¶7-200

TPD

¶7-210

trauma insurance

¶7-250

trusts

¶1-500

underwriter

¶7-080

unearned income

¶1-070

widely held trusts

¶5-330

will yield

¶19-030 ¶9-020

Departing Australia superannuation payments

¶15-400

Department of Veterans’ Affairs (DVA) benefits

¶6-400

concession cards

¶6-480

Disability Pensions

¶6-440

Service Pensions

¶6-420

War Widow/er Pension

¶6-460

Dependants death benefit payments definition

¶16-900–16-920 ¶4-425

estate planning for children

¶13-900

estate proceeds trusts

¶19-410

interdependency relationship

¶19-610

rebate

¶1-355; ¶20-040

self managed superannuation funds — sole purpose test

¶5-320

social security benefits — deceased estate superannuation death benefits — deductibility

¶19-960 ¶4-425; ¶19-365 ¶4-320

— tax rules

¶19-610

superannuation proceeds trusts

¶19-405

taxation of superannuation death benefits

¶20-305

Depreciable assets balancing adjustment

¶1-330

— CGT cost base

¶2-205

— CGT events

¶2-110

— compulsory acquisitions

¶2-410

business succession — effect of death on depreciable plants and buildings deductions family breakdown

¶19-810 ¶1-330

— CGT roll-over relief

¶18-505

rental property

¶12-300

small business CGT concessions

¶2-300

Depreciating assets accelerated depreciation

¶1-330

instant asset write-off

¶1-330

Derivation of income

¶1-250

Derivatives

¶9-335

contract for difference (CFD) hedge funds online investing Direct investing

¶9-335; ¶21-840 ¶9-345 ¶21-800 ¶9-420

Direct property investments versus shares

¶9-316

Direct shares saving for children's education

¶13-335

Direct value shifts CGT events

¶2-110

Disability benefits superannuation lump sums Disability Pensions (War Veterans)

¶14-330 ¶6-440

Disability Support Pension (DSP) economic response to COVID-19

¶6-050

economic support payments

¶6-180

manifest grants

¶6-180

Disciplinary body

¶8-265

Disclosure of adviser remuneration intra-fund advice

¶8-155

ongoing fee arrangements — adviser service fees

¶8-155

Disclosures

¶8-290

family breakdown

¶18-800

financial advisers — conflicts of interest

¶8-150

— Financial Services Guide (FSG)

¶8-300

— privacy laws

¶8-510

— Product Disclosure Statement (PDS)

¶8-320

— Record of Advice (RoA)

¶8-315

— retail or wholesale client

¶8-240

— Statement of Advice (SoA)

¶8-310

Discount capital gains and discount percentage

¶1-295; ¶2-215

acquisition of main residence

¶12-100

rates

¶20-150

Discretionary life interests

¶19-075

Discretionary trusts CGT — alienation of income

¶2-650

deceased estates, tax rules

¶19-700

family breakdown

¶18-615

— income splitting

¶18-620

— indemnities and guarantees

¶18-625

non-estate assets, estate planning

¶19-360

Discretionary will trusts

¶19-200

beneficiaries

¶19-215

beneficiary's choice to establish

¶19-215

capital gains tax opportunities

¶19-265

control

¶19-205

duration

¶19-200

establishment of more than one trust

¶19-225

estate proceeds trusts, distinguished

¶19-410

family law protection

¶19-270

future control

¶19-200

income tax savings

¶19-255

insolvency/potential liabilities, protection

¶19-260

planning opportunities

¶19-250

separate trusts

¶19-225

trusts and Age Pension entitlements

¶19-275

Disposal main residence

¶12-000

— absences from main residence

¶12-640

— adjacent land sold separately

¶12-670

— CGT partial exemption

¶12-580

— changing main residence

¶12-630

— deceased estates

¶12-800

— delay in moving

¶12-620

— destruction of dwelling and sale of land

¶12-650

— dwelling not originally established as main residence

¶12-590

— dwelling originally used as main residence

¶12-600

— main residence exemption exclusion for foreign residents

¶12-645

— profit-making scheme

¶12-510

— proposed superannuation benefits for downsizing

¶12-710

— retirement

¶12-700

— spouse/child separate dwelling

¶12-680

— tax consequences

¶12-500

Dispute resolution — see also Complaints resolution scheme external dispute resolution — proposal new framework

¶8-615

Distribution of assets deceased estates Distribution of personal chattels

¶19-505; ¶19-550–19-555 ¶19-065

Distribution washing

¶1-607

Diversification

¶9-080

direct property investment

¶9-316

Diversified funds geared investments

¶11-260

Diversified trusts

¶9-540

Dividend streaming arrangements anti-avoidance provisions

¶1-605

franking debits

¶1-405

Dividends assessable income

¶1-270

definition

¶9-020

dividend reinvestment plans

¶2-205

domestic equities

¶9-275

imputation — see Imputation system pooled development funds (PDFs)

¶1-400

withholding tax — rates

¶1-150

Divorce — see Family breakdown Domestic equities

¶9-250

industry sectors and subgroups

¶9-265

market indices

¶9-260

returns

¶9-275

Double tax agreements Downsizer contributions

¶1-550; ¶1-555 ¶4-223; ¶15-000; ¶15-198

recontribution strategy

¶17-025

Downsizer non-concessional contributions

¶18-400

Dow Jones Industrial Average

¶9-260

E Early release of superannuation benefits non-commutable income streams

¶15-110

retirement planning

¶15-400

Early retirement scheme — see Genuine redundancy and early retirement scheme Early stage innovation company (ESIC) tax offset for investments

¶1-355

Earnout rights arrangements

¶2-345

look-through earnout rights

¶2-345

— CGT small business concessions

¶2-345

— CGT treatment of qualifying earnout arrangements

¶2-345

sale of business — separate asset rule Economic effects

¶2-350

due to COVID-19

¶4-000; ¶4-400

Economic indicators online investing

¶21-600–21-630

Economic support payments due to COVID-19

¶6-050

— Age Pension, first and second payment

¶6-140

— Carer Payment

¶6-160

— Carer Allowance

¶6-170

— DSP

¶6-180

Education costs family financial planning

¶13-300

— additional mortgage repayments

¶13-340

— bank account

¶13-310

— direct shares

¶13-335

— geared investments

¶13-345

— grandparents paying school fees

¶13-355

— HECS

¶13-400

— HELP

¶13-400; ¶13-415–13-420

— insurance bonds

¶13-330

— investment options

¶13-305

— managed funds

¶13-320

— saving for children's education

¶13-305

— scholarship (education) funds

¶13-330

— student contribution options

¶13-405

— superannuation for children under 18

¶13-350

— term deposits

¶13-315

Educational resources websites

¶21-160

Eligible first home buyers

¶12-097

Eligible roll-over fund (ERF) superannuation entities Employee share acquisition schemes

¶4-120 ¶1-265; ¶10-470

assessable income

¶1-265

CGT

¶2-520

— cost base

¶2-205

Employees ATO limits

¶10-350

choice penalty

¶4-580

deductibility of transport expenses

¶3-500

deductible expenses

¶1-320

employment termination payments

¶20-100

expanded eligibility criteria due to COVID-19

¶6-190

expense payment fringe benefits

¶3-430

FBT — see Fringe benefits tax (FBT) government co-contributions

¶4-265; ¶20-340

interest-free loans

¶3-440

ordinary time earnings base

¶4-540

personal superannuation contributions — see Superannuation contributions pre-COVID wages

¶4-540

relocation of employment

¶3-500

salary packaging

¶10-000

— employee considerations

¶10-030

— employee share acquisition schemes

¶1-265; ¶10-470

self managed superannuation funds

¶5-020

shortfall exemption certificate

¶4-520

superannuation contributions

¶3-600

superannuation guarantee (SG) scheme

¶4-520

travel expenses

¶3-500

with multiple employers

¶4-520

working from home during COVID-19

¶12-060

Employer contributions Centrelink benefits salary sacrifice arrangement

¶4-215 ¶4-000; ¶4-500

— consequences for an employee

¶4-215

— reportable employer superannuation contributions

¶4-215

SG contributions

¶4-500

superannuation small business clearing house

¶4-000

Employer eligible termination payments — see Employment termination payments Employer payments — see Employment termination payments Employer superannuation contributions

salary sacrifice arrangement

¶4-000; ¶4-200

Employers automatic insurance cover

¶7-890

consequences for

¶4-520

COVID-19 — affected by

¶4-560

— cash flow boost subsidy

¶1-260

employer-provided child care

¶13-200

employment termination payments

¶20-100

enterprise agreement or workplace determination

¶4-580

FBT — see Fringe benefits tax (FBT) goods or services — trustee of a superannuation fund

¶4-580

JobKeeper payments

¶4-540

maximum contribution base

¶4-540

not liable for loss or damage

¶4-580

salary packaging

¶10-000

— employer considerations

¶10-020

— exempt and rebatable employers

¶10-620

— salary sacrifice into superannuation

¶10-430

SG charge

¶4-560

shortfall exemption certificate

¶4-000; ¶4-540; ¶4-520

superannuation contributions

¶3-600; ¶4-205; ¶4-210

— following salary sacrifice

¶4-215

superannuation guarantee (SG) scheme — choice of fund rules — contributions

¶4-580 ¶4-500; ¶4-510

— increase

¶4-540

— obligations

¶4-560

Employment employment-related payments — rates and tables — genuine redundancy and early retirement scheme payments

¶20-110

— termination payments

¶20-100

— unused annual leave payment rules

¶20-115

— unused long service leave payment rules

¶20-120

FBT

— employer-employee relationship — required by employers

¶3-100 ¶3-100; ¶3-150

salary packaging

¶10-000

— living-away-from-home allowance

¶10-350

— total employment cost

¶10-040

Employment income report to Centrelink

¶6-050

Employment remuneration trusts arrangements FBT

¶3-430

Employment termination payments death benefit termination payments

¶14-250

genuine redundancy or early retirement scheme payments

¶14-250

income tax invalidity

¶1-285 ¶14-300

life benefit termination payments — see Life benefit termination payments transitional rules

¶14-250

Endowment insurance assessable income

¶1-275

Endowment warrants geared investments

¶11-750

Enduring guardian

¶19-455

Enduring power of attorney

¶15-560; ¶19-455; ¶19-460

Enduring power of attorney (medical treatment)

¶19-455

Enduring Power of Guardianship

¶15-560

Entertainment expenses fringe benefits

¶3-700

meal and other entertainment benefits

¶3-200

Entry contribution (EC)

¶17-030

Equity investments domestic international equities retirement incomes Equity trusts

¶9-250–9-275 ¶9-300 ¶16-587 ¶9-520

Estate assets

¶19-020

Estate planning

¶19-000

CGT — deceased estates

¶19-150–19-165

— gifts to tax-exempt organisations

¶19-160

— main residence exemption

¶19-155

children

¶13-900

— family law provision

¶13-900

— financial provisions

¶13-910

— intestacy

¶13-900

— nomination of guardian

¶13-905

— testamentary trusts

¶13-915

consequences of death

¶19-500–19-520; ¶19-800–19-810; ¶19-950– 19-960

discretionary will trusts — planning opportunities distributing the assets estate assets family breakdown — blended families

¶19-250–19-275 ¶19-550; ¶19-555 ¶19-020 ¶18-000–18-020 ¶18-830

further planning opportunities — estate proceeds trusts

¶19-410

— superannuation proceeds trusts

¶19-405

— taking advantage of rules for minors

¶19-400

importance

¶19-010

non-estate assets objectives

¶19-020; ¶19-350–19-370 ¶19-035

powers of attorney

¶19-450–19-475

restricted trusts

¶19-300–19-315

retirement planning

¶15-590

rules that apply to different types of assets

¶19-600–19-635

rules that apply to different types of beneficiaries

¶19-750–19-765

rules that apply to different types of entitlements under wills

¶19-650–19-715

self managed superannuation funds tax returns testamentary trusts

¶5-040 ¶19-900–19-910 ¶19-165; ¶19-850

— tax rates on trust income

¶19-555

wills — see Wills Estate proceeds trusts

¶19-410

Estate testamentary trusts

¶13-915

Ethical investments

¶9-370

European securities online investing Excess concessional contributions charge rates Commissioner's discretion

¶21-730 ¶4-234 ¶4-235; ¶15-050 ¶4-235; ¶4-250

defined benefit interest

¶4-234

penalties imposed

¶4-235

retirement planning

¶15-050

self managed superannuation funds — transfers from reserves

¶5-700

special circumstances

¶4-250

Excess determination retirement incomes — starting an income stream — exceeding the transfer balance cap

¶16-170

Excess non-concessional contributions

¶4-240

election to withdrawal

¶4-245

exclusion of contributions of amounts

¶4-240

liability to tax

¶4-245

self managed superannuation funds

¶5-350

— transfers from reserves

¶5-700

tax treatment

¶4-245

Exchange traded funds (ETFs) bond index products

¶9-535; ¶21-900 ¶9-180

investments

¶21-910

smart beta

¶21-920

Exchange traded options and share futures geared investments Exchange traded products

¶11-800

Exchange traded funds (ETFs)

¶21-900

investing in ETFs

¶21-910

smart beta

¶21-920

Excluded benefits

¶10-400

salary packaging

¶10-060

— employee share schemes

¶10-470

— salary sacrifice into superannuation

¶10-430

Excluded from FBT rules employer arrangements

¶10-400

salary sacrifice into superannuation

¶10-430

— impact of concessional contributions cap

¶10-430

Executors asset distribution

¶19-505

commission

¶19-050

deceased estates — CGT

¶19-150

— duties and powers

¶19-510

self managed superannuation funds

¶5-020

wills

¶19-050

Exempt current pension income (ECPI)

¶16-700

Exempt fringe benefits

¶10-500

salary packaging

¶10-000

— frequent flyer benefits

¶10-530

— in-house child care

¶10-540

— laptops and work-related equipment

¶10-520

— long service awards

¶10-550

— other exempt benefits

¶10-570

Exemptions CGT

¶2-250

— exempt assets, proceeds and transactions

¶2-270

— 15-year asset

¶2-336

— 50% active asset

¶2-337

— foreign and temporary residents

¶2-280

— pre-CGT assets

¶2-260

— small business retirement

¶2-338

earnout arrangements

¶2-345

FBT

¶3-600

— car expense benefits

¶3-200; ¶3-600

— car parking benefits

¶3-200

— concessional capping thresholds

¶3-650

— expense payment benefits

¶3-200

— loan fringe benefits

¶3-200

— multiple portable electronic devices — small businesses

¶3-600

— reportable employer superannuation contributions

¶3-155

— reporting requirements

¶3-155

income

¶1-260

— trusts

¶1-505

Existing advisers

¶8-265

Expatriates salary packaging Expense payment fringe benefits

¶10-670 ¶3-200; ¶3-430; ¶3-500

exempt expense payment fringe benefits

¶3-430

external expense payment benefit

¶3-200

in-house expense payment benefit

¶3-200

Expenses ATO guidelines on deductibility of particular types

¶3-500

home office running expenses — temporary shortcut method for running costs payment fringe benefit Extra allowable amount (EAA) External dispute resolution (EDR)

¶12-066 ¶3-500 ¶17-030 ¶8-615

F Fair trading

¶8-410

Family Assistance payments

¶6-350

— see also Family Tax Benefits Family breakdown CGT — realisation and taxation costs

¶18-300

— roll-over relief — topical checklist

¶2-410; ¶12-210; ¶12-215; ¶18-505 ¶2-700

child support — see Child support discretionary trusts — elections

¶18-615

— income splitting

¶18-620

— indemnities and guarantees

¶18-625

discretionary will trusts

¶19-270

introduction

¶18-000; ¶18-005

— de facto relationships

¶18-015; ¶18-120

— estate and financial planning — Family Court land tax

¶18-020 ¶18-010; ¶18-120 ¶18-610

loan accounts — see Family companies main residence exemption

¶12-200–12-215

maintenance — adult child

¶18-710

— child maintenance trusts

¶18-715

— child support

¶18-705

— spouse

¶18-700

other issues — alternate dispute resolution

¶18-835

— bankruptcy

¶18-820

— estate planning for blended families

¶18-830

— Family Court's powers over business entities

¶18-810

— financial agreements

¶18-825

— full and frank disclosure

¶18-800

— subpoena

¶18-805

— third parties standing in the Family Court

¶18-815

property settlement

¶18-100

— assessment of contributions

¶18-110

— “future needs”, s 75(2)

¶18-115

— identification of the property pool

¶18-105

— justice and equity

¶18-120

stamp duty exemptions

¶18-600

— main residence

¶18-605

superannuation death benefits

¶18-205; ¶18-830

superannuation splitting

¶4-480; ¶18-200

— binding death benefit nominations

¶18-205

— taxation

¶18-400

taxation wills, effect

¶18-300–18-515 ¶19-085

Family companies family breakdown — CGT roll-over

¶18-505

— Court's power

¶18-810

— deemed dividends

¶18-510

— loan accounts

¶18-510

— third party interests

¶18-810

negative gearing

¶11-225

Family Court

¶18-010

family breakdown

¶18-000

— bankruptcy

¶18-820

— de facto matters

¶18-010; ¶18-120

— powers over business entities

¶18-810

— same sex couples

¶18-010

— subpoena

¶18-805

— third parties standing

¶18-815

Family financial planning

¶13-000

child care

¶13-200

— costs

¶13-205

— employer-provided child care

¶13-200

— options

¶13-200

— subsidy

¶13-730

child support or maintenance

¶13-800

— child maintenance trusts

¶13-810

child support scheme — child support agreements

¶13-805

— child support and impact on family tax benefit

¶13-805

— child support assessments

¶13-805

— child support ordered by the court

¶13-805

— income for child support assessments

¶13-805

children's education

¶13-300

— additional mortgage repayments

¶13-340

— bank account

¶13-310

— direct shares

¶13-335

— geared investments

¶13-345

— grandparents paying school fees

¶13-355

— HECS

¶13-400

— HELP

¶13-400; ¶13-415–13-420

— insurance bonds

¶13-330

— investment options

¶13-305

— managed funds

¶13-320

— saving for children's education

¶13-305

— scholarship (education) funds

¶13-330

— student contribution options

¶13-405

— superannuation for children under 18

¶13-350

— term deposits

¶13-315

children's savings options

¶13-500

— special disability trusts

¶13-510

— teaching children value of money

¶13-505

combined HELP loan limit

¶13-410

debt management

¶13-100

— myths and strategies

¶13-105

— repayment of non-deductible debts

¶13-105

— reviewing repayments

¶13-100

estate planning for children

¶13-900

— family law provision

¶13-900

— financial provisions

¶13-910

— intestacy

¶13-900

— nomination of guardian

¶13-905

— testamentary trusts

¶13-915

financial goals — budget planning

¶13-060

— budgeting and goal setting

¶13-050

— cost of raising children

¶13-070

government family payments

¶13-700

— Family Tax Benefits

¶13-710–13-720

— Grandparent Child Care Subsidy

¶13-735

— income test for Family Tax Benefits

¶13-725

— paid parental leave

¶13-705

— Parenting Payment

¶13-740

— Youth Allowance

¶13-745

HELP loans and repayments — income assessed to determine repayments

¶13-410

— maximum loan amount

¶13-410

taxation of children's income

¶13-600

— excepted income of minors

¶13-605

— issues for trustees

¶13-620

— minor is an excepted person

¶13-610

— social security implications

¶13-625

— unearned income of minors

¶13-615

Family home — see Main residence Family payments family financial planning — Family Tax Benefits

¶13-700 ¶13-710–13-720

— Grandparent Child Care Subsidy

¶13-735

— income test for Family Tax Benefits

¶13-725

— paid parental leave

¶13-705

— Parenting Payment

¶13-740

— Youth Allowance

¶13-745

Family Tax Benefits (FTB) — see also Family Assistance payments economic response to COVID-19 family financial planning

¶6-050 ¶13-710–13-720

— income test

¶13-725

Newborn Supplement

¶13-705

Newborn Upfront Payment

¶13-705

Part A — income test limits

¶20-572

— rates of payment

¶20-570

Part B — income test

¶20-574

— rates

¶20-574

— Supplement

¶20-574

Family trusts

deductible losses discretionary will trust beneficiaries

¶1-525 ¶19-215

family breakdown — CGT roll-over relief

¶18-505

— income and taxation opportunities

¶18-615

— income splitting

¶18-620

— indemnities and guarantees

¶18-625

— taxation

¶18-450

negative gearing

¶11-225

testamentary allocations

¶19-115

Farm household allowance (FHA)

¶6-050

NARWP

¶6-750

Farmers FHA income support FBT concessional employers FBT rebate rate

¶6-050 ¶10-620 ¶3-650

Federal Budget capital gains tax — 2017 Federal Budget measures — discount capital gains and discount percentage

¶2-215

— foreign resident capital gains withholding payments

¶2-280

— main residence and other exemptions

¶1-295

— roll-over relief for merging superannuation funds

¶2-410

compulsory HELP repayment levels — 2017 Federal Budget

¶13-415

gearing — investments in superannuation funds — projections

¶11-520

— managed funds

¶11-260

regulation of superannuation entities — Superannuation Complaints Tribunal

¶4-150

2017 proposals — first home super saver scheme

¶12-098

— main residence exemption exclusion for foreign residents — temporary and foreign residents

¶12-645

— main residence exemption — family home

¶12-580

— proposed superannuation benefits for downsizing

¶12-710

— social security

¶14-430

Fee Disclosure Statement (FDS) remuneration and disclosure renewal notice and Fee-for-no-service FEE-HELP

¶8-155 ¶8-010; ¶8-155 ¶8-170 ¶13-410

Fees investment bonds reduced aged care fees

¶9-600 ¶16-620

Film concessions

¶1-355

Film incentives

¶9-360

Financial Adviser Standards and Ethics Authority (FASEA) Approved Degree list Code of ethics

¶8-000; ¶8-120; ¶15-005 ¶8-265 ¶8-155; ¶8-265

continuing professional development standard

¶8-265

education requirements

¶8-265

practice questions and guidance on website

¶8-265

pre-FASEA duty

¶8-130

professional designations

¶8-265

public register of financial advisers

¶8-265

recognition of prior learning (RPL)

¶8-265

the exam

¶8-265

Financial advisers

¶8-010

ban of conflicted remuneration

¶8-010

best interest duty

¶8-010

best practice

¶8-100; ¶8-280

— appropriate advice

¶8-125

— best interest duty

¶8-120

— competencies, experience and training

¶8-170

— conflicts of interest

¶8-150

— disclosure to clients — efficiently, honestly and fairly — Future of Financial Advice (FOFA) reforms — key elements

¶8-290–8-320 ¶8-140 ¶8-000; ¶8-020; ¶8-120 ¶8-110

— “know-your-client, know-your-product” rule

¶8-130

— “know-your-client” rule

¶8-120

— professional codes and standards

¶8-190

— quality advice

¶8-130

— remuneration and disclosure

¶8-155

— supervision

¶8-180

complaints handling system

¶8-600

— external dispute resolution (EDR)

¶8-615

— how to act

¶8-610

compliance consumer protection

¶8-000; ¶8-010 ¶8-400–8-425

Corporations Act 2001

¶8-420

— fair trading

¶8-410

— misleading and deceptive conduct

¶8-405

— other laws

¶8-425

— penalties for breaches of corporate laws

¶8-420

— professional indemnity insurance

¶8-420

— restrictive trade practices

¶8-415

court cases

¶8-125

financial services panel

¶8-010

internet legislative framework

¶21-950 ¶8-020

margin lending

¶11-350

misconduct by

¶8-020

ongoing client engagement and fee disclosure

¶8-010

online financial planning

¶21-950–21-995

privacy compliance — Australian Privacy Principles (APPs)

¶8-510

— role of financial advisers

¶8-520

superannuation splitting

¶18-200

Financial agreements family breakdown

¶18-825

Financial goals family financial planning — budget planning

¶13-060

— budgeting and goal setting

¶13-050

— cost of raising children

¶13-070

Financial hardship cashing superannuation benefits

¶15-400

compulsory HELP repayments, variations

¶13-415

Financial Ombudsman Service (FOS)

¶8-615

Financial planners advice on SMSFs

¶5-800

family breakdown

¶18-000–18-020

online financial planning

¶21-950–21-995

rates and tables

¶20-000–20-580

tax-related advice

¶8-350

Financial Planning Association (FPA)

¶8-155

Financial planning online

¶21-950

financial planning clients needs

¶21-960

financial resources

¶21-995

other financial service providers, competition

¶21-980

Robo-advice

¶21-990

websites

¶21-970

Financial plans

¶8-010

Financial products advice

¶8-230

— training of financial product advisers

¶8-260

anti-hawking

¶8-420

dealing in

¶8-230

definition

¶8-220

excluded products

¶8-220

making a market

¶8-230

Financial resources websites

¶21-995

Financial Services Council (FSC)

¶7-998

Financial Services Guide (FSG)

¶8-300

Financial System Inquiry (FSI)

¶8-020

Financial year

income tax

¶1-100

First home buyer

¶12-096

grant

¶12-010

First home loan deposit scheme

¶12-090

first home buyers

¶12-097

First home owner government grants and assistance — additional benefits

¶12-092

— first home super saver scheme

¶12-098

grant

¶12-091

HomeBuilder scheme

¶12-092

transfer duty

¶12-096

First Home Super Saver scheme (FHSS)

¶4-222; ¶12-000; ¶12-098

eligible contributions

¶4-222

eligible individuals

¶4-222

liability to tax

¶4-222

withdrawn contributions

¶4-222

Fixed interest at call money bonds

¶9-110 ¶9-160–9-180

debentures

¶9-150

international fixed interest

¶9-200

property loans and margin lending

¶11-400

retirement incomes

¶16-587

short-term money markets

¶9-130

term deposits

¶9-140

Fixed interest investments borrowing Fixed interest securities

¶11-450 ¶9-110

Fixed term income stream assessment assets test

¶16-592

income test

¶16-592

Fixed term income streams comparison of income streams

¶16-195

income stream types

¶16-200

— advantages and disadvantages

¶16-260

— investment security

¶16-250

maximising income levels

¶16-600

Fixed trusts CGT treatment of foreign residents

¶2-280

Flexible paid parental leave days

¶13-705

Fly-in fly-out (FIFO)/drive-in drive-out (DIDO) rules

¶10-350

Foreign Accumulation Fund (FAF) rules

¶9-300

Foreign capital gains

¶2-520

Foreign currency hedging transactions capital gains tax — other exemptions or loss-denying transactions — foreign currency hedging contracts

¶2-343

CGT exemption

¶2-270

Foreign exchange gains and losses assessable gains

¶1-275

Foreign exchange market currency trading online

¶21-430

Foreign income accruals taxation

¶1-570

foreign income tax offset

¶1-575

foreign losses

¶1-580

tax offset

¶1-575

transferor trusts

¶1-570

Foreign income tax offset (FITO)

¶2-520

Foreign investment Australian resident — accruals taxation

¶1-570

— assessable income

¶1-565

geared investments — quarantining provisions online investing — see International investing

¶11-230

thin capitalisation rules

¶1-560

Foreign investment funds (FIFs) taxation

¶9-300

Foreign losses

¶1-580

partnerships

¶1-455

Foreign resident beneficiary exemption fixed trust

¶2-360

Foreign resident exemption foreign trusts and beneficiaries

¶2-360

Foreign residents capital gains withholding payments

¶2-280

CGT — becoming resident

¶2-280

— discount CGT

¶2-215

— exemptions and withholding tax

¶2-280

discount percentage for particular taxpayers

¶2-217

taxable Australian property (TAP)

¶2-280

taxes — additional taxes on foreign resident owners

¶12-075

— CGT withholding tax

¶12-070

— clearance certificate

¶12-072

— tax withheld

¶12-071

Foreign source income partnerships

¶1-455

trusts

¶1-505

Foreign superannuation funds Qualifying Recognised Overseas Pension Scheme — transfer of pension benefits from UK to Australia

¶4-650

superannuation benefits

¶4-650

taxation

¶4-600

— income streams Franked distributions Franking of dividends — see Imputation system

¶16-800 ¶2-360

Frequent flyer benefits salary packaging

¶10-530

Fringe benefits — see also Fringe benefits tax (FBT); Reportable fringe benefits benefit subject to FBT definition

¶3-150 ¶3-100; ¶3-200

FBT liability

¶3-800

GST

¶3-950

not included in calculation of capping thresholds

¶3-650

rates and tables — interest rates for car and loan fringe benefits

¶20-220

— statutory fractions for car benefit valuation

¶20-210

— tax rate

¶20-200

reportable fringe benefits — employee considerations

¶3-155 ¶10-030

— reportable employer superannuation contributions

¶3-155

social security benefits

¶6-360

Fringe benefits tax (FBT)

¶3-000

airline transport

¶3-445

benefit subject to FBT

¶3-150

calculation

¶3-300

— car benefits

¶3-410

— car parking fringe benefits

¶3-420

— employee contributions

¶3-550

— expense payment benefits

¶3-430

— in-house benefits

¶3-445

— in-house benefits, salary sacrifice arrangements

¶3-445

— living-away-from-home allowance fringe benefits

¶3-450

— loan fringe benefits

¶3-440

— “otherwise deductible” rule

¶3-500

— taxable values

¶3-400; ¶3-500

definition

¶3-050

exemptions and concessions

¶3-600

— exempt employers

¶3-650

— other concessions and caps

¶3-700

— rebatable employers

¶3-650

FBT basics

— employer-employee relationship

¶3-100

— required by employers

¶3-100

FBT rules — employer arrangements

¶10-400

— impact of concessional contributions cap

¶10-430

— salary sacrifice into superannuation

¶10-430

fringe benefits

¶3-200

income tax — interaction between FBT

¶1-090

— reporting benefits provided

¶1-090

— salary sacrifice

¶1-090

payment of FBT

¶3-150

planning — impact on employees

¶3-900

— interaction with other taxes

¶3-950

— reducing liability

¶3-800

— salary packaging or sacrifice

¶3-850

rates

¶20-200

reportable fringe benefits

¶3-155

— allocation between employees

¶3-155

— excluded fringe benefits

¶3-155

— gross-up FBT rate for reporting on payment summary

¶3-155

— reportable employer superannuation contributions

¶3-155

salary packaging

¶10-000

— calculation of FBT liabilities

¶10-200

— income tax interaction

¶10-240

— salary sacrificed benefits

¶10-260

Fund managers research

¶9-800

Fundamental analysis based tip sheets websites

¶21-240

Fundamental research online investing — basic charting facilities

¶21-260

— company announcements

¶21-220

— finding investment candidates

¶21-200

— fundamental analysis based tip sheets

¶21-240

— new listings

¶21-250

— stock filters

¶21-230

Funds Under Advice (FUA) Future of Financial Advice (FOFA) reforms

¶8-125 ¶8-010; ¶8-020; ¶8-120

interest requirement interact with FASEA Code of Ethics

¶8-120

pre-FOFA duty

¶8-130

Futures market

¶9-335

assessable income

¶1-275

geared investments

¶11-800

online investing

¶21-810

G Gearing

¶11-000

borrowing — becoming non-resident

¶11-240

— CGT trap on retirement

¶11-500

— deductions/purpose of loan

¶11-200

— diversified funds

¶11-260

— fixed interest investments

¶11-450

— foreign investments

¶11-230

— geared investment projections

¶11-550

— guarantors/third party security providers

¶11-252

— interest rates

¶11-400

— managed funds

¶11-260

— margin lending

¶11-350; ¶11-355; ¶11-360

— maximising after-tax returns

¶11-255

— name of investor

¶11-250

— PAYG tax

¶11-270

— property loans

¶11-355; ¶11-360

— protected or insured loans

¶11-420

— risk of excessive gearing

¶11-360

— superannuation funds

¶11-520

— timing of deductions

¶11-220

— trusts and companies

¶11-225

— unsecured loans

¶11-330

checklist

¶11-150

existing geared investments

¶11-160

geared investments

¶11-010

— advantages

¶11-010

— saving for children's education

¶13-345

negative gearing

¶11-050

— retirement planning

¶15-035

other forms of geared investments — endowment warrants

¶11-750

— exchange traded options and share futures

¶11-800

— full details of projections

¶11-900

— geared share managed funds

¶11-600

— instalment warrants

¶11-700

— options offered by companies

¶11-650

General interest charge (GIC) late payment of tax

¶1-750

tax shortfall

¶1-755

Genuine redundancy and early retirement scheme

¶14-000; ¶14-100

early retirement scheme, definition

¶14-210

employer payments

¶14-250

genuine redundancy, definition

¶14-200

investing payout versus debt pay-off

¶14-450

planning checklist for redundancy

¶14-120

social security

¶14-430

tax concessions

¶14-110; ¶14-220

tax-free redundancy payment, calculation

¶14-260

tax treatment

¶20-110

unused annual leave

¶14-230

unused long service leave

¶14-240

Gifting rules assets test

¶6-860

social security benefits

¶6-670

Gifts capital gains tax — other exemptions or loss-denying transactions

— gifts of property

¶2-343

CGT cost base

¶2-205

deductions

¶1-345

financial and estate planning on family breakdown — property settlement — assessment of contributions

¶18-110

— identification of property pool

¶18-105

property pool

¶18-105

testamentary — adjustment to beneficiary entitlements

¶19-115

— beneficiaries attaining nominated age

¶19-060

— charities and superannuation funds

¶19-755

— contingent gifts

¶19-660

— Cultural Bequests Program

¶19-760

— personal chattels

¶19-065

— tax-exempt organisations

¶19-160

— will drafting Global Financial Crisis (GFC)

¶19-060; ¶19-065 ¶11-000

Gold investments online investing Golden handshake

¶21-440 ¶1-285; ¶14-220; ¶14-250

Goods and services tax — see GST Governing rules — see Trust deeds Government economic support payments due to COVID-19 Government co-contributions retirement planning

¶6-050 ¶4-265; ¶20-340 ¶15-195

Government grants and assistance concessions for family home

¶12-090

first home owners, additional benefits

¶12-092

first home owners’ grant

¶12-091

first home super saver scheme

¶12-098

home owners, other benefits

¶12-096

Grandparent Child Care Subsidy

¶13-735

Granny flats interests establishment of

¶17-030

granny flat arrangement

¶17-030

social security means-test assessment of

¶17-030

value of, determined

¶17-030

Gross-up rates reportable fringe benefits Type and Type 2

¶3-155 ¶3-155; ¶3-300

Group insurance cover

¶7-930

benefits offered under group policies

¶7-935

continuation option

¶7-940

group policies, advantages and disadvantages

¶7-950

Growth trusts

¶9-540

GST FBT interaction fringe benefits — employee contributions input tax credits, CGT

¶1-090; ¶3-950 ¶3-300 ¶3-550; ¶3-950 ¶2-520

main residence

¶12-080

— acquisition

¶12-081

— renovations/repairs

¶12-083

— rental property

¶12-084

— sale

¶12-082

rental property — taxation implications of Airbnb

¶12-350

Guarantors/third party security providers geared investments

¶11-252

Guardians appointment

¶19-055

estate planning for children — nomination

¶13-905

powers of attorney

¶19-455

H Hardship

deceased estate tax exemption

¶19-900

Health retirement planning Health Care Card Health promotion charities (HPCs)

¶15-560 ¶6-360; ¶13-715 ¶3-650

HECS — see Higher Education Loan Program (HELP) HECS-HELP

¶13-410

Hedge funds

¶9-345

Hedging transactions

¶9-335

international trusts

¶9-530

Henry Review

¶16-115

High income earners concessional contributions — deduction

¶4-225

Higher Education Contribution Scheme (HECS)

¶13-400

Higher Education Loan Program (HELP)

¶20-080

debts

¶4-215

family financial planning

¶13-400

— bankruptcy

¶13-415

— compulsory HELP repayment levels

¶13-415

— debt on death

¶13-415

— loans and repayments

¶13-410

— repaying debt

¶13-420

— variations to compulsory repayments

¶13-415

— voluntary HELP repayments — abolished

¶13-415

HomeBuilder scheme

¶12-092

COVID-19 — eligible owner-occupiers

¶12-096

Home care Commonwealth Home Support Programme (CHSP)

¶17-110

— assessment and access

¶17-110

— cost of

¶17-110

— and home care packages (HCP)

¶17-110

— home care packages (HCP)

¶17-120

— assessment and access

¶17-120

— type of care and services available

¶17-120

— cost of

¶17-120

— receiving services and support

¶17-100

— services available

¶17-110

home care packages (HCP) — assessment and access

¶17-120

— care and services, type of

¶17-120

— cost of

¶17-120

— fees, types

¶17-120

Home loans — see Mortgages Home office CGT main residence exemption deductions

¶12-056 ¶1-320; ¶12-060

— occupancy costs

¶12-066

— personal services income rules

¶12-065

— place of business — place of convenience

¶12-062–12-068 ¶12-060; ¶12-062

— running costs

¶12-066

— work-related expenses

¶12-068

expenses — temporary shortcut method for running costs

¶12-066

working from home during COVID-19

¶12-060

Home owners basic assets test

¶20-550

government grants and assistance — additional benefits for first home owners

¶12-092

— first home super saver scheme

¶12-098

— other benefits

¶12-096

Homeownership

¶17-030

Home reversion schemes

¶12-700

Housing fringe benefits

¶3-200

remote area concessions

¶3-700; ¶10-650

Hybrid securities

¶9-350

I Immediate annuities retirement incomes

¶16-145

Imputation system assessable income

¶1-270

domestic equities

¶9-275

franking accounts

¶1-405

franking credits — investment bonds

¶9-600

— maximum

¶1-405

— retirement incomes — self managed superannuation funds — shareholder's death

¶16-587 ¶5-600 ¶19-620

franking debits

¶1-405

franking rebates

¶1-270

pooled development funds (PDFs)

¶1-400

tainted share capital accounts

¶1-405

In-house assets self managed superannuation funds

¶5-330

In-house child care — see also Child care salary packaging In-house fringe benefits Income and assets test assessment of investments

¶10-540 ¶3-445; ¶3-700 ¶6-500 ¶6-600–6-660

assets test

¶6-520

Austudy

¶6-250

comparison of income streams

¶16-195

definition of income

¶6-350

Family Tax Benefits

¶13-725

gifting rules

¶6-670

income streams

¶6-640

income test

¶6-540

property investments

¶6-660

reverse mortgages

¶6-660

social security benefits — allowances

¶20-540

— clean energy supplement

¶20-450

— Family Tax Benefits

¶20-572; ¶20-574

— home owners

¶20-550

— non-home owners

¶20-560

— pensions

¶20-530

strategies

¶6-800

— assets test

¶6-860

— income test

¶6-840

term allocated pensions

¶16-400

Income producing buildings business succession CGT cost base

¶19-810 ¶2-205

Income producing property — see also Buildings repairs

¶1-325

retirement incomes

¶16-587

Income protection

¶7-370

accident insurance

¶7-360

APRA changes

¶7-345

agreed value policy

¶7-320

benefit period

¶7-340

cancellable policy

¶7-310

definition

¶7-300

indemnity value policy

¶7-320

level of cover

¶7-320

non-cancellable policy

¶7-310

offset clauses

¶7-320

personal sickness

¶7-360

tax implications

¶7-350

waiting period

¶7-340

Income splitting personal services income retirement incomes

¶1-610

— withdrawals as lump sums or income

¶16-589

Income streams — see also Annuities Superannuation income streams comparisons

¶16-195

complying income streams — commutations

¶16-840

— criteria

¶16-830

death benefits

¶16-900

— child account-based pensions

¶16-930

— commutation

¶16-920

— taxation

¶16-910

— transfer balance caps

¶16-940

economic impacts of COVID-19 income tax

¶6-640 ¶16-700; ¶16-710

— before 1 July 2007

¶16-720

— commenced from 1 July 2007

¶16-710

— commutation pre-1 July 2007

¶16-760

— commutations

¶16-780

— death benefit income stream

¶16-910

— deductible amount

¶16-720

— exempt current pension income (ECPI)

¶16-700

— foreign superannuation income streams

¶16-800

— maximising tax free component

¶16-750

— non-complying Australian funds

¶16-810

— relevant number

¶16-740

— tax offset

¶16-770

— under the PAYG system

¶16-730

longevity income streams and CIPRs — Comprehensive Income Products for Retirement (CIPRs)

¶16-570

— deferred superannuation income streams

¶16-570

maximising retirement incomes

¶16-600–16-640

— retirement income covenant

¶16-135

retirement incomes — benefits of deferred income stream products CIPRs

¶16-145

— categories

¶16-130

— changing income stream providers

¶16-640

— pensions or annuities

¶16-130

— selection

¶16-145

transfer balance cap rules — commencement — non-concessional contribution caps

¶4-227–4-232; ¶16-150 ¶15-020; ¶15-190

— spouse contribution splitting

¶15-192

transitional CGT relief

¶16-168

types — comparison

¶16-190–16-570 ¶16-195

Income support payments due to COVID-19

¶6-050

Income tax

¶1-000

assessable income — see Assessable income assessments — see Assessments calculation — interaction between income tax and FB — Medicare levy and surcharge

¶1-090 ¶1-075; ¶3-950; ¶20-025

— minors

¶1-070

— self-assessment

¶1-060

— tax losses

¶1-065

— tax payable

¶1-055

— taxable income

¶1-050

CGT — index numbers

¶20-160

— rates

¶20-150

children's income company tax

¶13-600–13-625 ¶1-400; ¶1-405

cross-border issues — accruals taxation system

¶1-570

— Australians investing overseas

¶1-565

— foreign losses

¶1-580

— resident v non-resident

¶1-550

— source of income

¶1-555

— thin capitalisation

¶1-560

death benefit income stream

¶16-910

deceased estates — income and testamentary trusts — returns

¶19-855 ¶19-900–19-910

deductions — see Deductions discretionary will trusts exempt income

¶19-255 ¶1-260

family breakdown

¶18-300

— CGT roll-over relief

¶18-505

— deemed dividends and company loans

¶18-510

— Part IVA considerations

¶18-515

— property

¶18-500

— realisation and taxation costs

¶18-300

— superannuation concessions and taxation

¶18-400

— tax losses

¶18-305

— taxation liabilities

¶18-105

— trusts

¶18-450

fringe benefits — tax

¶20-200–20-220 ¶1-090

geared investments — guarantors/third party security providers income streams

¶11-252 ¶16-700; ¶16-710

— before 1 July 2007

¶16-720

— commenced from 1 July 2007

¶16-710

— commutation pre-1 July 2007

¶16-760

— exempt current pension income (ECPI)

¶16-700

— foreign superannuation income streams

¶16-800

— maximising tax free component

¶16-750

— non-complying Australian funds

¶16-810

— relevant number

¶16-740

— tax offset

¶16-770

— taxation of commutations

¶16-780

— under the PAYG system

¶16-730

main residence, disposal

¶12-500

— profit-making scheme

¶12-510

offsets — see Tax offsets partnerships

¶1-450–1-465

payment and collection — Australian Business Number (ABN)

¶1-120

— collections of tax

¶1-105

— failure to quote TFN

¶1-115

— financial and income year

¶1-100

penalties

¶1-750

— administrative penalties

¶1-755

— offences against taxation laws

¶1-760

personal tax offsets and rebates — rates

¶20-040

rates — see Income tax rates rates and tables — approved deposit funds (ADFs)

¶20-060

— companies and life insurance companies

¶20-070

— employment termination payments

¶20-100

— general redundancy and early retirement scheme

¶20-110

— superannuation benefits — superannuation contributions — unused leave

¶20-300; ¶20-305 ¶20-310–20-340 ¶20-115; ¶20-120

rental property — taxation implications of Airbnb

¶12-350

returns — see Tax returns review of assessments and other decisions

¶1-710

rulings — see also Taxation Rulings — binding on Commissioner

¶1-660

— objection and review

¶1-665

— role

¶1-650

— scope

¶1-650

salary packaging

¶10-000

— FBT interaction

¶10-240

self managed superannuation fund investments

¶5-600

social security benefits

¶6-310

superannuation funds — benefits paid — complying status

¶4-300–4-390; ¶20-060 ¶4-420 ¶4-310; ¶4-320

— contributions

¶4-280

— death benefits

¶4-425

— no-TFN contributions income

¶4-390

— non-complying funds

¶4-310; ¶4-340

— PSTs

¶4-360

— superannuation benefits

¶4-420

tax avoidance

¶1-600–1-615

trusts

¶1-500–1-525

withholding tax

¶1-150

Income tax rates

¶1-055

CGT

¶20-150

— index numbers

¶20-160

companies and life insurance companies

¶20-070

employment termination payments

¶1-285; ¶20-100

fringe benefits

¶20-200–20-220

genuine redundancy and early retirement scheme payments

¶20-110

HELP

¶20-080

low income tax offset

¶20-045

Medicare levy

¶20-020

— surcharge

¶20-025

minors

¶20-035

non-resident individuals

¶20-030

personal tax offsets and rebates

¶20-040

resident individuals

¶20-010

salary packaging

¶10-000

— interaction of FBT and income tax

¶10-240

senior Australians and pensioner tax offset

¶20-043

small business income tax offset

¶20-075

superannuation benefits superannuation contributions

¶20-300; ¶20-305 ¶20-310–20-340

superannuation funds

¶15-020; ¶20-060

superannuation guarantee charge

¶20-400; ¶20-410

testamentary trust income

¶19-855

unused leave entitlements — annual leave

¶20-115

— long service leave

¶20-120

withholding tax

¶1-150

Income test assessment account-based pension (ABP) temporary changes due to COVID-19 term allocated pension (TAP) Income tested care fee (ITCF)

¶16-591 ¶6-540 ¶16-596

strategies to manage

¶17-120

Income year income tax

¶1-100

Independent living arrangements independent living units retirement villages

¶17-230 ¶17-200; ¶17-210

— social security assessment and costs of

¶17-240

Supported Residential Services (SRS)

¶17-220

Indexation average weekly ordinary time earnings CGT fixed term income streams

¶20-290 ¶2-210; ¶2-215 ¶16-200

retirement incomes — transfer balance cap and starting an income stream transfer balance cap

¶16-155 ¶4-229

Indices general stock market

¶9-260

Individually Managed Accounts (IMAs)

¶9-610

Individuals financially affected by COVID-19

¶4-435

gross tax

¶1-055

main residence

¶4-223

Industry sector rotation

¶21-630

Infrastructure projects investments

¶9-325

Inheritances financial and estate planning on family breakdown — property settlement — assessment of contributions

¶18-110

— identification of property pool

¶18-105

Insolvency practitioners declaration of worthless shares Instalment gearing Instalment trusts

¶2-110 ¶11-350 ¶2-220

look-through tax treatment Instalment warrants geared investments

¶2-250 ¶8-220; ¶9-340 ¶11-700

Instant asset write-off acquisition of motor vehicles car cost depreciation limit depreciating assets

¶1-330 ¶1-283; ¶1-330 ¶1-330

Insurance commissions — remuneration and disclosure

¶8-155

life annuities — see Lifetime income streams life risk insurance — see Life risk insurance policies — see Insurance policies retirement planning

¶15-580

risks associated with gearing

¶11-150

taxation of complying funds — deduction for disability insurance premiums

¶4-320

taxation through superannuation — death cover

¶7-860

— salary continuation (income protection)

¶7-860

— terminal illness payment

¶7-860

— TPD benefits

¶7-860

Insurance bonds saving for children's education

¶13-330

Insurance cover acceptance of insurance policy

¶7-460

amount of insurance cover required

¶7-500

— client needs analysis

¶7-510

— recommended insurance amount, calculation

¶7-520

application process

¶7-400

disclosure requirements for life insurance

¶7-450

ongoing obligations of life insurance company

¶7-470

underwriting role and process

¶7-410

Insurance for businesses

¶7-600

business expenses insurance

¶7-610

Insurance in Superannuation Working Group (ISWG) — voluntary code of practice

¶7-998

Insurance in Superannuation Voluntary Code of Practice

¶7-998

Insurance in Superannuation Working Group (ISWG)

¶7-998

Insurance industry volume-based bonuses

¶8-155

Insurance policies permanent

¶7-060

term

¶7-055

Intangible assets development, enhancement, maintenance, protection and exploitation (DEMPE)

¶2-650

Interest assessable income

¶1-270

car fringe benefits

¶20-220

deceased estate tax returns

¶19-910

deductibility

¶1-325

— thin capitalisation rules

¶1-560

geared investments — deductibility

¶11-200–11-270

— loans

¶11-330–11-450

loan fringe benefits

¶20-220

main residence acquisition/construction — interest deduction generators

¶12-110

— offset arrangements

¶12-110

— split loan arrangements

¶12-110

partnership borrowings

¶1-455

separate asset rule — collectables

¶2-350

— CGT improvement threshold

¶2-350

— interest in land

¶2-350

withholding tax — rates International economic indicators International equities

¶1-150 ¶21-620 ¶9-300

foreign investment fund taxation

¶9-300

International fixed interest

¶9-200

International investing Asian securities

¶21-740

European securities

¶21-730

international stock exchanges

¶21-710

online

¶21-700

US securities

¶21-720

International share funds geared managed fund

¶11-600

International stock exchanges online investing

¶21-710

International trading services online brokers International trusts

¶21-100 ¶9-530

Internet use for investing

¶21-010

Intestacy

¶19-515

estate planning — for children

¶13-900

estate proceeds trust

¶19-410

wills

¶19-047

Intra-fund advice

¶8-155

Invalidity definition

¶14-300

segment — pension or lump sum

¶14-440

superannuation lump sum — disability benefit

¶14-330

termination of employment — life benefit termination payment

¶14-320

— lump sum or pension

¶14-440

— social security rules

¶14-430

unused leave entitlements

¶14-310

Invalidity Service Pension

¶6-420

Investing online — see Online investing Investment bonds Investment candidates

¶9-600 ¶21-200

Investment chatrooms websites

¶21-120

Investment products Australian equity trusts

¶9-520

Australian fixed interest trusts

¶9-480

Australian property trusts

¶9-500

cash management account

¶9-470

direct investing

¶9-420

diversified trusts

¶9-540

exchange traded funds (ETFs)

¶9-535

international trusts

¶9-530

investment bonds

¶9-600

listed investment companies

¶9-535

master trusts and wrap accounts

¶9-430

mortgage offset

¶9-490

mortgage trusts

¶9-495

unit trusts

¶9-450

Investment properties — see Gearing Investment strategies alternative investment strategies to superannuation

¶15-035

retirement planning — risk return

¶15-017

— time horizons

¶15-017

self managed superannuation funds

¶5-400

Investment timing and dollar cost averaging

¶9-020

Investments

¶9-000

assessable income

¶1-270

assets, classes — defensive

¶9-070

— growth

¶9-070

cash assets

¶9-070

chatrooms — see Investment chatrooms deductions

¶1-325

definitions — business cycle

¶9-070

— compound interest

¶9-020

— dividend

¶9-020

— investment timing and dollar cost averaging

¶9-020

— opportunity costs

¶9-070

— simple interest

¶9-020

— yield

¶9-020

diversification

¶9-080

domestic equities

¶9-250

— industry sectors and subgroups

¶9-265

— market indices

¶9-260

— returns

¶9-275

early stage innovation company (ESIC) — tax offsets

¶1-355

fixed interest

¶11-450

— at call money

¶9-110

— Australian fixed interest trusts

¶9-480

— bonds

¶9-160–9-180

— debentures

¶9-150

— international fixed interest

¶9-200

— pricing differentials

¶9-180

— securities

¶9-110

— short-term money markets

¶9-130

— term deposits

¶9-140

— yield curve

¶9-170

gearing — see Gearing international equities

¶9-300

— foreign investment fund taxation

¶9-300

investment products managed funds research

¶9-420–9-610 ¶9-800

negative gearing — see Gearing online — see Online investing performance measurement

¶9-700

— benchmarks

¶9-710

— portfolio reviews

¶9-815

— risk assessment

¶9-720

— summary

¶9-720

pools of wealth — lifestyle wealth

¶9-050

— peace of mind wealth

¶9-050

— retirement wealth

¶9-050

products — see Investment products property — direct property versus shares

¶9-316

— listed property trusts

¶9-312

— property returns and valuation

¶9-314

— residential property

¶9-310

rates and tables — social security — deeming rates and thresholds

¶20-545

retirement planning — risk return

¶15-017

— time horizons

¶15-017

self managed superannuation funds

¶5-220–5-600

social security assessment

¶6-580–6-670

specialist assets

¶9-320–9-400

J JobKeeper Payment

¶4-540

due to COVID-19

¶6-050

JobSeeker income test

¶6-190

residential qualifications for allowances

¶6-185

Job Plan JobSeeker Payment

¶6-190

Parenting Payment

¶6-240

JobSeeker Payment changes to income and assets tests

¶14-430; ¶14-450; ¶20-450; ¶20-560 ¶6-190

COVID-19 — expanded eligibility criteria

¶6-190

— Supplement

¶6-190

eligibility criteria

¶6-190

leave payments

¶6-190

mutual obligation requirements

¶6-190

NARWP

¶6-750

ordinary waiting period

¶6-705

Parenting Payment

¶6-240

partner income test

¶6-540

replaced Newstart Allowance

¶6-190

self-employment, sufficient work test

¶6-190

temporary removal of waiting periods

¶6-190

JobKeeper scheme

¶4-540

Joint attorneys by majority

¶19-470

joint and several appointments

¶19-470

Joint tenancy capital gains or losses

¶2-220

deceased estates

¶19-695

estate planning

¶19-355

K Key person insurance benefits of policy

¶7-660

case study

¶7-690

identifying a key person

¶7-650

structuring policies

¶7-670

tax implications

¶7-680

L Land, CGT rules Land lease community

¶2-350 ¶15-570

Land tax deceased estates — death and liability

¶19-955

family breakdown

¶18-610

on resident non-occupying owners Landlords, deductions

¶12-057 ¶1-325

Laptop computers FBT expense payment benefits

¶3-430

Law Administration Practice Statements

¶1-650

Law Companion Guidelines (LCG)

¶1-650

Leases capital gains tax — other exemptions or loss-denying transactions — leases not used for income-producing purposes

¶2-343

CGT

¶2-110

— excluded transactions

¶2-270

remote area housing FBT benefits

¶3-700

Leases and lease arrangements self managed superannuation funds

¶5-330

Leave payments JobSeeker Payment Legacies, deceased estates

¶6-190 ¶19-655

Legal personal representatives — see Executors Level premiums

¶7-910

Levies additional taxes on foreign resident owners — annual agency fee for foreign-owned vacant residential properties superannuation supervisory levies

¶12-075 ¶4-150

Licensee AML-CTF program

¶8-180

Licensing financial advisers — Australian clearing and settlement facility licence

¶8-250

— Australian financial market licence

¶8-250

— Australian Financial Services Licence (AFSL)

¶8-250

Life annuities — see Lifetime income streams Life benefit termination payments

calculation of invalidity segment

¶14-320

components

¶14-250

genuine redundancy or early retirement scheme payments

¶14-250

social security

¶14-430

superannuation contribution caps

¶14-425

taxation

¶1-285

— exempt component

¶1-285

— tax free component

¶1-285

— taxable component

¶1-285

Life estates discretionary life interest

¶19-075

fixed life interest

¶19-070

tax rules

¶19-710

Life Expectancy Tables

¶20-250

Life insurance — see also Life risk insurance deceased estates

¶19-615

estate planning

¶19-370

importance — incidence of death and disability

¶7-075

— underinsurance problem

¶7-070

inside superannuation

¶7-800

— cross-insurance and self-managed funds

¶7-870

— funding premiums

¶7-840

— insurance in super and low-balance or inactive accounts

¶7-890

— meeting the sole purpose test

¶7-830

— non-business reasons, advantages and disadvantages

¶7-820

— reserving strategies

¶7-880

— structure

¶7-810

— tax deductions for premiums

¶7-850

— taxation of insurance

¶7-860

key participants and documents — definitions

¶7-080

overview — permanent insurance policies

¶7-060

— role of life insurance

¶7-050

— term insurance policies

¶7-055

retirement planning

¶15-580

term life insurance — see Term life insurance Life Insurance Code of Practice

¶7-998

Life insurance companies definition income tax rates ongoing obligations

¶7-080 ¶20-070 ¶7-470

segregated pension assets

¶16-700

Life Insurance Framework

¶8-020

sale of life insurance policies

¶8-155

Life insurance genetic test

¶7-410

Life insurance policies assessable income

¶1-275

Life insurance products — see Financial products Life insurance framework and remuneration reforms ASIC sample life insurance SOA

¶7-997

codes of practice, life insurance

¶7-998

life insurance commissions and conflicted remuneration

¶7-995

Corporations Amendment (Life Insurance Remuneration Arrangements) Regulations 2017

¶7-995

— remuneration changes

¶7-995

Royal Commission, recommendations

¶7-999

Trowbridge report and outcomes

¶7-990

Life risk insurance

¶7-000

amount of insurance cover

¶7-500

— client needs analysis

¶7-510

— recommended insurance amount, calculation

¶7-520

— ASIC sample life insurance SOA

¶7-997

business succession planning

¶7-700

— components of buy/sell plan

¶7-710

— structuring buy/sell insurance

¶7-720

— tax implications for buy/sell arrangements

¶7-760

claims process — see Claims process codes of practice, life insurance complaints process

¶7-998

— complaints for insurance inside superannuation

¶7-985

— raising life insurance complaint

¶7-980

group insurance cover

¶7-930

— benefits offered under group policies

¶7-935

— continuation option

¶7-940

— group policies, advantages and disadvantages

¶7-950

income protection — see Income protection insurance cover — acceptance of insurance policy

¶7-460

— application process

¶7-400

— disclosure requirements for life insurance

¶7-450

— ongoing obligations of life insurance company

¶7-470

— underwriting role and process

¶7-410

insurance for businesses

¶7-600

— business expenses insurance

¶7-610

key person insurance — benefits of policy

¶7-660

— case study

¶7-690

— identifying a key person

¶7-650

— structuring policies

¶7-670

— tax implications

¶7-680

life insurance commissions and conflicted remuneration

¶7-995

life insurance framework

¶7-990

life insurance, importance — incidence of death and disability

¶7-075

— underinsurance problem

¶7-070

life insurance inside superannuation — see Superannuation life insurance, key participants and documents — definitions

¶7-080

life insurance, overview — permanent insurance policies

¶7-060

— role

¶7-050

— term insurance policies

¶7-055

Royal Commission, recommendations

¶7-999

stepped versus level premiums

¶7-900–7-910

term life insurance — life insurance (death) cover

¶7-100

— tax implications for death cover

¶7-150

total and permanent disability (TPD) insurance — bundled or linked TPD

¶7-220

— definition

¶7-200

— stand-alone policy

¶7-220

— tax implications

¶7-230

— TPD, definition

¶7-210

trauma insurance — definition

¶7-250

— tax implications for trauma cover

¶7-270

— trauma claim events

¶7-250

Trowbridge report

¶7-990

Life tenants — see Life estates Lifetime income streams

¶16-300

advantages and disadvantages

¶16-360

capital access schedule (CAS)

¶16-593

comparison of income streams

¶16-195

income stream types — guarantee period and death benefits

¶16-300

— income payments

¶16-300

— indexation of income

¶16-300

— joint or single names

¶16-300

maximising income

¶16-600

pooled lifetime income stream, definition

¶16-593

purchased before 1 July 2019

¶16-593

purchased from 1 July 2019

¶16-593

reversionary nominations

¶16-330

Limited partnerships income tax Limited recourse borrowing arrangements (LRBA) limited circumstances total superannuation balance

¶1-400 ¶4-000; ¶4-228; ¶4-233; ¶8-220 ¶5-360 ¶4-233; ¶5-360

Limited recourse loans deductible interest

¶1-325

Limousine

¶3-600

Linked and split loan facilities deductibility of additional interest Liquid Assets Waiting Period

¶1-325 ¶6-050; ¶6-190; ¶6-250

Liquidators capital gains or losses

¶2-220

declaration of worthless shares

¶2-110

Listed investment companies (LICs)

¶9-535

investments in

¶2-217

Listed property trusts investments

¶9-312

online investing

¶21-410

Living-away-from-home allowance (LAFHA)

¶10-300

FBT

¶3-200

fringe benefits

¶3-450

salary packaging

¶10-350

12-month exemption rule

¶10-350

Loans accounts — family breakdown

¶18-510

balance check — myhelpbalance.gov.au early repayment

¶13-410; ¶13-420 ¶2-200

family financial planning — debt management

¶13-100

— HELP loans and repayments

¶13-410

fringe benefits

¶3-200; ¶3-440

— interest rates

¶20-220

— salary packaging

¶10-340

gearing investments — see Gearing HELP loans and repayments

¶13-410

private company shareholders

¶1-400

self managed superannuation funds

¶5-370

wills, adjustment to beneficiary entitlement Long service awards

¶19-115

salary packaging

¶10-550

Long service payments — see Unused leave entitlements Loss-denying transactions capital gains tax — exemptions, concessions and special rules — foreign currency hedging contracts

¶2-343

— gifts of property

¶2-343

— leases not used for income-producing purposes

¶2-343

— mining rights of genuine prospectors

¶2-343

— native title and rights to native title benefits

¶2-343

— Norfolk Island residents

¶2-343

— other transactions and circumstances

¶2-343

— relationship breakdown settlements

¶2-343

— strata title conversions

¶2-343

Losses or outgoings company tax deceased estates

¶1-400 ¶19-910

deductions

¶1-300

— business income

¶1-310

— investments

¶1-325

employer not liable for loss or damage

¶4-580

from bad investments

¶11-010

income protection insurance

¶7-345

investment losses

¶4-228

non-deductible

¶1-305

partnerships

¶1-455

Low and middle income tax offset (LMITO) Low-balance accounts

¶1-050; ¶1-355 ¶7-890

Low income earners compulsory HELP repayments, variations

¶13-415

Medicare levy

¶20-020

personal superannuation contributions — deduction — government co-contributions

¶4-220 ¶20-340

rebates — minors

¶20-035

tax offsets

¶1-355; ¶20-045

Low income or non-working spouse superannuation contributions — offset — retirement planning Low income tax offset (LITO)

¶4-275; ¶20-330 ¶15-190 ¶1-355; ¶20-045

contributions to superannuation funds

¶4-270

Low rate cap amount

¶4-420

Lump sum accommodation fee residential care facility

¶17-025

Lump sum payments Age Pension

¶6-140

Carer Payment

¶6-160

Carer Allowance

¶6-170

DSP

¶6-180

Luxury car limit accelerated depreciation

¶1-330

Luxury cars fringe benefits

¶3-410

M Main residence

¶12-000

acquisition/construction — financing

¶12-110

— structuring acquisition

¶12-100

CGT exemption

¶1-295; ¶2-270; ¶12-050; ¶12-053; ¶12-580

— deceased estates

¶19-605

— disposal

¶12-052

— dwelling

¶12-053

— estate planning

¶19-155

— family home

¶12-580

— home constructed on vacant land

¶12-120

— home office

¶12-056

— maximisation

¶2-600

— person ceasing to be Australian resident

¶12-051

— use for income-producing purposes

¶12-056

CGT withholding tax — clearance certificate

¶12-070; ¶12-071 ¶12-072

concessions — family home

¶12-090

deductibility of home expenditure

¶12-060

— occupancy costs

¶12-066

— place of business

¶12-062; ¶12-065

— place of convenience

¶12-060; ¶12-062

— running costs

¶12-066

— work-related expenses

¶12-068

disposal — absences from main residence

¶12-640

— adjacent land sold separately

¶12-670

— CGT consequences

¶12-052

— CGT exemption

¶12-053

— CGT partial exemption

¶12-580

— changing main residence

¶12-630

— deceased estates

¶12-800

— delay in moving

¶12-620

— destruction of dwelling and sale of land

¶12-650

— dwelling not originally established as main residence

¶12-590

— dwelling originally used as main residence

¶12-600

— profit-making scheme

¶12-510

— retirement

¶12-700

— spouse/child separate dwelling

¶12-680

— tax consequences

¶12-500

family breakdown — CGT roll-over relief

¶12-210; ¶12-215; ¶18-505

— property settlement

¶12-200

— stamp duty

¶18-605

grants — first home owner’s grant

¶12-091

— other benefits

¶12-096

GST

¶12-080

— acquisition

¶12-081

— renovations/repairs

¶12-083

— rental property

¶12-084

— sale

¶12-082

home office — see Home office home ownership

¶12-005

— advantages and disadvantages

¶12-010

— strategies

¶12-010

renting out whole or part

¶12-300

— taxation implications of Airbnb

¶12-350

social security benefits — assets-test exemption Main residence exemption

¶6-520; ¶6-560 ¶2-280; ¶4-223; ¶12-050; ¶12-051; ¶12-052

CGT event

¶12-645

exclusion for foreign residents

¶12-645

life events test

¶12-645

Maintenance family breakdown

¶18-000

— adult child

¶18-710

— child maintenance trusts

¶18-715

— child support

¶18-705

— spouse

¶18-700

Managed accounts Individually Managed Accounts (IMAs)

¶9-610

Separately Managed Accounts (SMAs)

¶9-610

Managed Expense Ratio (MER)

¶8-010

Managed funds — see also Unit trusts benchmarks

¶9-710

CGT — foreign resident's interest

¶2-280

— non-assessable payments

¶2-205

geared investments

¶11-260

geared investments in shares

¶11-600

online investing

¶21-500

— brokers

¶21-100

— investment tools

¶21-510

performance measurement research saving for children's education

¶9-700–9-720 ¶9-800 ¶13-320

Managed investment schemes

¶8-230

Managed Investment Trusts (MITs)

¶2-250

additional discount for qualifying affordable housing

¶2-217

CGT tax

¶2-215

proposed changes

¶2-250

Margin calls and COVID-19

¶11-350

Margin lending

¶11-350; ¶11-355; ¶11-360

financial product

¶8-220

obligations on financial advisers

¶8-220

protected or insured loans

¶11-420

retirement planning

¶15-035

Marital breakdown

¶18-400

Market linked income streams — see Term allocated pensions (TAPs) Marriage breakdown — see Family breakdown

Marriage or de facto relationship Master funds

¶18-105 ¶4-110

— see also Unit trusts Master trusts Mature Age Allowance

¶9-430 ¶20-540

Meal entertainment benefits salary packaging

¶10-370; ¶10-620

Means tests — see Income and assets test Medical expenses date-of-death returns rebate Medicare levy

¶19-910 ¶1-355 ¶1-075; ¶20-020; ¶20-025

low income earners

¶20-020

Senior Australians and pensioners

¶20-020

superannuation income streams surcharge Mergers, CGT

¶1-290 ¶1-075; ¶3-950; ¶4-215; ¶20-025 ¶2-205

Migrants social security benefits, waiting period

¶6-750

Mining rights, CGT

¶2-110

capital gains tax — other exemptions or loss-denying transactions — mining rights of genuine prospectors

¶2-343

Minors — see Children Misleading and deceptive conduct

¶8-405

MoneySmart Mortgage Calculator

¶13-105

Mortgage offset

¶9-490

Mortgage trusts

¶9-495

Mortgagees capital gains or losses

¶2-220

Mortgages deceased estate

¶19-705

interest deduction generators

¶12-110

offset arrangements

¶12-110

saving for children's education — additional mortgage repayments

¶13-340

split loan arrangements

¶12-110

My Aged Care ACAT assessment

¶17-320

cost of a HCP

¶17-120

retirement living and aged care

¶17-000

MySuper accounts

¶8-155

N National Consumer Credit Law

¶8-410

National Stock Exchange of Australia (NSX)

¶2-110

Negative gearing borrowing

¶11-050 ¶11-200–11-520

definition

¶11-050

examples

¶11-050

fundamental rule

¶11-050

retirement planning

¶15-035

Newborn Supplement

¶13-705

New entrants

¶8-265

New listings online investing Newly Arrived Residents Waiting Period (NARWP)

¶21-250 ¶6-050; ¶6-190; ¶6-240; ¶6-250; ¶6-750

economic impacts of COVID-19

¶6-750

temporary suspension

¶6-185

Newstart Allowance

¶20-540

No-TFN contributions income income tax Non-account based income streams retirement incomes

¶4-390 ¶16-190 ¶16-130; ¶16-145

Non-arm’s length income

¶5-040

complying superannuation funds

¶4-320

Non-assessable non-exempt income Non-commutable income streams

¶1-255; ¶1-260; ¶3-600 ¶15-110; ¶16-585; ¶16-620

Non-complying superannuation funds — see Superannuation funds Non-concessional contributions impact retirement planning — annual cap spouse contributions superannuation — operation of bring forward cap treatment Non-concessional contributions cap

¶4-235 ¶15-048 ¶4-240 ¶15-190 ¶4-200 ¶20-320 ¶4-200 ¶18-400

Non-estate assets

¶19-020; ¶19-350

discretionary trusts

¶19-360

jointly owned assets

¶19-355

life insurance

¶19-370

superannuation funds

¶19-365

Non-fringe benefits

¶3-600

Non-home owners basic assets test

¶20-560

Non-profit employers FBT — exempt employers

¶3-650; ¶10-620

— rebatable employers

¶3-650; ¶10-620

— rebate

¶3-650

Non-residents assessable income beneficiaries

¶1-255 ¶19-765

CGT — discount CGT

¶2-215

— withholding tax

¶1-295

exempt income

¶1-260

franked dividends

¶1-270

geared investments

¶11-240

income tax

¶1-550

— source of income

¶1-555

— thin capitalisation rules

¶1-560

income tax rates

¶20-030

— minors

¶20-035

partnership net income or loss

¶1-455

taxable Australian real property

¶2-280

trusts

¶1-505

— beneficiary presently entitled

¶1-510

withholding tax

¶1-295

— rates

¶1-150

Non-share investments

¶21-400

commodities

¶21-440

currency

¶21-430

debt markets

¶21-420

property

¶21-410

Non-superannuation complying annuities

¶16-830

Non-testamentary assets

¶13-615

Not-for-profit capping threshold

¶3-650

Not-for-profit employers

¶3-650

Not-for-profit hospitals

¶3-650

Notional earnings notional taxed contributions — excess concessional contributions

¶4-234

— low income superannuation tax offset

¶4-270

— tax on contributions of high income earners

¶4-225

retirement incomes — starting an income stream — exceeding the transfer balance cap

¶16-170

Novated car leases fringe benefits

¶3-410

O Objections to tax assessment deceased estates

¶1-710 ¶19-900

private ruling

¶1-665

Offences, income tax

¶1-760

Office of the Australian Information Commissioner (AOIC)

¶8-010

Off-market share buy-backs

¶2-110

Ongoing expenses deductions for investors and landlords Ongoing fee arrangements (OFAs)

¶1-325 ¶8-010; ¶8-020; ¶8-155

Online brokers websites

¶21-100

Online investing

¶21-000

advanced investing

¶21-800

— contract for difference (CFD)

¶21-840

— derivatives

¶21-800

— Exchange traded funds (ETFs)

¶21-900

— futures

¶21-810

— options

¶21-830

— warrants

¶21-820

blogs

¶21-130

financial planners and internet

¶21-950

— client needs today

¶21-960

— competition with other service providers

¶21-980

— evolving financial planning business

¶21-970

— online financial planning resources

¶21-995

fundamental research — basic charting facilities

¶21-260

— company announcements

¶21-220

— finding investment candidates

¶21-200

— new listings

¶21-250

— stock filters

¶21-230

— tip sheets

¶21-240

international investing

¶21-700

— Asian securities

¶21-740

— European securities

¶21-730

— international stock exchanges

¶21-710

— online

¶21-700

— US securities

¶21-720

managed funds

¶21-500

— investment tools

¶21-510

non-share investments

¶21-400

— commodities

¶21-440

— currency

¶21-430

— debt markets

¶21-420

— property

¶21-410

online resources — educational resources

¶21-160

— investment chatrooms

¶21-120

— online brokers

¶21-100

— other resources

¶21-180

— portfolio management online

¶21-110

— share trading clubs

¶21-140

— smart phone and tablet applications

¶21-136

— stock and market news

¶21-150

— twitter accounts

¶21-135

protections

¶21-020

Robo-advice

¶21-990

socially responsible

¶21-170

superannuation

¶21-540

technical analysis — benefits

¶21-300

— charting tools set up

¶21-310

— complementing with fundamental data

¶21-320

— data services

¶21-310

— tip sheets

¶21-330

tracking business cycle

¶21-600

— monitoring economy

¶21-610

— monitoring international economy

¶21-620

— sector rotation

¶21-630

using the internet

¶21-010

websites — for financial planners

¶21-970

— online financial planning resources

¶21-995

On-market share buy-backs

¶2-110

Opt-in renewal notice remuneration and disclosure

¶8-155

Options CGT

¶2-355

— company shares and units in unit trust

¶2-355

— cost base calculation

¶2-205

continuation

¶7-940

deceased estates derivatives

¶19-685 ¶9-335

exchange traded options

¶11-800

geared investments

¶11-650

online investing

¶21-830

premiums for life insurance

¶7-900

— level premiums

¶7-910

— stepped premiums

¶7-905

Ordinary time earnings base

¶4-540

Ordinary Waiting Period economic impacts of COVID-19

¶6-050; ¶6-190; ¶6-240; ¶6-250 ¶6-705

Overseas investors — see Foreign investment Owner-occupiers HomeBuilder — eligibility criteria

¶12-096

— renovation contract

¶12-096

P Paid employment, self-supporting Paid parental leave Paid parental leave period

¶6-250 ¶6-350; ¶13-705; ¶20-578 ¶6-050; ¶6-350

Keeping in Touch days

¶13-705

Parental leave pay flexible paid parental leave days new rules to Parenting Payment

¶13-705 ¶6-050; ¶6-350; ¶13-705 ¶13-740

COVID-19 — economic response to

¶6-050

— temporary measures

¶6-240

NARWP

¶6-750

ordinary waiting period

¶6-705

rate of payment and means testing

¶6-240

Partner Allowance Partner Service Pension

¶6-230; ¶6-360; ¶20-540 ¶6-420

Partnerships assessable income

¶1-280

capital gains or losses

¶2-220

death of partner — business succession

¶19-800

— depreciable plants and buildings

¶19-810

— effect of death on trading stock

¶19-805

— life insurance

¶19-615

— tax returns

¶19-910

definition family breakdown

¶1-450 ¶18-620

income tax

¶1-450

— assignment of interest

¶1-465

— direct application of law to partners

¶1-460

— limited partnerships

¶1-400

— net income or loss

¶1-455

— salaries and payments to associated persons

¶1-455

personal services income splitting

¶1-610

Partner/Sickness Allowance

¶20-450

PAYG instalments

¶1-105

annual instalments

¶1-105

date-of-death returns

¶19-910

geared investments, effect

¶11-270

income streams

¶16-700

monthly instalments

¶1-105

quarterly instalments

¶1-105

PAYG withholding

¶1-105

dividends, interest and royalties

¶1-150

income streams

¶16-730

Payment of tax

¶1-100

collection systems

¶1-105

Payment summaries reportable fringe benefits — impact on employees

¶1-090; ¶3-155 ¶3-900

Penalties administrative

¶1-755

breaches of corporate laws

¶8-420

choice of superannuation fund rules

¶4-580

civil penalty provisions

¶8-350; ¶8-510

financial advisers Corporations Act 2001

¶8-420

— misleading and deceptive conduct

¶8-405

— restrictive trade practices

¶8-415

insufficient superannuation contributions

¶4-560

self managed superannuation funds

¶5-700

shortfall interest charge (SIC)

¶1-750

Penalty interest

¶2-200

Penalty tax

¶1-750–1-760

Pension Bonus Scheme (PBS)

¶6-320

Pension payments

¶4-228

Pension tables — see also Pensions account-based pensions, minimum and maximum pension valuation factors

¶20-260

account-based pensions, minimum annual pension payments

¶20-240

life expectancy factors

¶20-250

term allocated pensions, payment factors

¶20-270

Pensioner nil condition of release

¶5-600

Pensioner Concession Card

¶6-360

economic response to COVID-19

¶6-050

Pensions — see also Pension tables; Superannuation pensions administration

¶6-100

Age Pension

¶6-140

Age Service Pension

¶6-420

assessable income

¶1-265

assets test basic income test

¶6-520; ¶6-860 ¶20-530

Carer Payment

¶6-160

Carers Supplement

¶6-160

Disability Pensions (War Veterans)

¶6-440

Disability Support Pension (DSP)

¶6-180

housing in retirement

¶6-560

income test

¶6-540

Invalidity Service Pension

¶6-420

maximum benefit entitlement

¶20-460

Partner Service Pension

¶6-420

residential qualifications

¶6-135

senior Australians and pensioners tax offset

¶1-355; ¶20-043

Service Pensions

¶6-420

War Widow/er Pension

¶6-460

Performance measurement managed funds

¶9-700

— industry benchmarks for investments

¶9-710

— managed funds research

¶9-800

— portfolio reviews

¶9-815

— risk assessment

¶9-720

Personal deductible contribution

¶15-000

Personal services income

¶1-265

FBT interaction

¶3-950

— exempt car fringe benefit

¶3-200

home office deductions

¶12-065

income splitting

¶1-610

Personal superannuation contributions — see Superannuation contributions Personal use assets CGT — deceased estates — topical checklist

¶2-340 ¶19-630 ¶2-700

Pooled development funds (PDFs) income tax

¶1-400

Pooled superannuation trusts (PSTs) — see also Superannuation entities definition

¶4-120

income tax

¶4-360

— rates — superannuation fund investment

¶20-060 ¶4-320

Portfolio management online websites Portfolio reviews

¶21-110 ¶9-815

Powers of attorney

¶19-450

joint and several appointments

¶19-470

jurisdiction of assets

¶19-465

legal requirements

¶19-465

registration

¶19-465

revocation of power of attorney

¶19-475

scope of authority

¶19-460

supervision of attorney

¶19-465

types

¶19-455

— advance health care directive

¶19-455

— enduring guardian

¶19-455

— enduring power of attorney

¶19-455

— enduring power of attorney (medical treatment)

¶19-455

— general power of attorney

¶19-455

— supportive attorney

¶19-455

Practical Compliance Guidelines (PCG)

¶1-650

employer contributions

¶4-203

Pre-CGT asset

¶4-223

Pre-FASEA duty Pre-FOFA duty

¶8-130 ¶8-000; ¶8-130; ¶8-300

Pre-nuptial agreements — see Financial agreements Precious metals online investing

¶21-440

Preservation age

¶15-025

Preserved superannuation benefits conditions of release

¶15-400

contribution and earnings

¶4-400

preservation age

¶4-400

withdrawal of benefits

¶4-400

Principal residence — see Main residence Privacy compliance compulsory data breach notifications

¶8-510; ¶8-520 ¶8-520

Private companies business succession

¶19-800

excessive remuneration

¶1-400

loans to shareholders

¶1-400

payments deemed dividends

¶1-270

Private equity investments

¶9-355

Private health insurance tax offset

¶1-355

Private trusts

¶6-620

Probate

¶19-100; ¶19-505

Product Disclosure Statement (PDS)

¶8-320

definition

¶7-080

Product Rulings

¶1-650

Professional indemnity (PI) insurance Professional Investor test

¶8-240; ¶8-420 ¶8-240

Profit from good investments Profit-making schemes

¶11-010 ¶2-110

Property deferred transfers of title, CGT

¶2-110

geared investment projections

¶11-550

profit on sale

¶1-275

residential

¶9-310

taxation Property fringe benefits

¶18-500 ¶3-200; ¶3-500

Property investments direct property versus shares

¶9-316

income test

¶6-660

— strategies

¶6-840

listed property trusts

¶9-312

online investing

¶21-410

residential property

¶9-310

returns and valuation

¶9-314

Property loans geared investments — margin loan, comparisons

¶11-355

— risk of excessive gearing

¶11-360

Property settlement family breakdown — assessment of contributions — Family Court

¶18-110 ¶18-010; ¶18-120

— four-step approach

¶18-100

— “future needs”, s 75(2)

¶18-115

— investment properties

¶18-500

— justice and equity

¶18-120

— main residence

¶12-200

— property pool, identification

¶18-105

— superannuation splitting

¶4-480; ¶18-200; ¶18-205

Protected loans margin lending providers Public ambulance services Public benevolent institutions (PBIs)

¶11-420 ¶3-650

FBT-exempt benefits

¶3-650

Public hospitals

¶3-650

Public offer superannuation funds

¶4-110

Public sector funds

¶4-110

Public trading trusts

¶1-400

Public unit trusts

¶1-500

Q Qualifying Recognised Overseas Pension Scheme (QROPS) foreign superannuation benefits — transfer of pension benefits from UK to Australia

¶4-650

Quality advice pre-FASEA, pre-FOFA duty Quality of lifestyle

¶8-130 ¶15-010

R Rates and tables

¶20-000

capital gains — capital gains tax rate

¶20-150

— CGT index numbers

¶20-160

employment-related payments — genuine redundancy and early retirement scheme payments

¶20-110

— termination payments

¶20-100

— unused annual leave payment rules

¶20-115

— unused long service leave payment rules

¶20-120

fringe benefits — interest rates for car and loan fringe benefits

¶20-220

— statutory fractions for car benefit valuation

¶20-210

— tax rate

¶20-200

income tax rates — companies and life insurance companies

¶20-070

— Higher Education Loan Program

¶20-080

— low income tax offset

¶20-045

— medicare levy

¶20-020

— medicare levy surcharge

¶3-950; ¶20-025

— minors

¶20-035

— non-resident individuals

¶20-030

— personal tax offsets and rebates

¶20-040

— resident individuals

¶20-010

— Senior Australians and pensioner tax offset

¶20-043

— small business income tax offset

¶20-075

— superannuation funds, ADFs and PSTs

¶20-060

indexation — average weekly ordinary time earnings

¶20-290

payment of superannuation benefits — taxation of superannuation benefits

¶20-300

— taxation of superannuation death benefits

¶20-305

pension tables — life expectancy factors

¶20-250

— minimum and maximum pension valuation factors

¶20-260

— minimum annual pension payment percentages — account-based pensions

¶20-240

— payment factors — term allocated pensions

¶20-270

social security — aged care

¶20-580

— basic assets test for home owners

¶20-550

— basic assets test for non-home owners

¶20-560

— basic income test for allowances

¶20-540

— basic income test for pensions

¶20-530

— clean energy supplement

¶20-450

— deeming rates and thresholds

¶20-545

— Family Tax Benefit Part A income test limits

¶20-572

— Family Tax Benefit Part A rates of payment

¶20-570

— Family Tax Benefit Part B rates of payment

¶20-574

— maximum benefit entitlement for allowances

¶20-470

— maximum benefit entitlement for pensions

¶20-460

— paid parental leave

¶20-578

superannuation contributions — concessional contributions cap

¶20-310

— government co-contributions

¶20-340

— non-concessional contributions cap

¶20-320

— spouse contributions

¶20-330

superannuation guarantee charge — charge percentage

¶20-400

— maximum contribution base

¶20-410

Re-contribution strategy

¶15-180

maximising tax-free component

¶15-180

Real estate CGT topical checklist

¶2-700

self managed superannuation fund acquisition

¶5-500

Rebatable employers

¶3-650

Rebates — see also Tax offsets concessional rebates and offsets

¶1-355

FBT rebatable employers

¶3-650

— salary packaging

¶10-620

film concessions

¶1-355

franking credits

¶1-405

franking of dividends

¶1-270

investments in early stage innovation company (ESIC)

¶1-355

low income aged persons

¶1-355

low income earners

¶1-355

medical expenses rebate

¶1-355

personal tax offsets and rebates

¶20-040

spouse superannuation contributions

¶20-330

zone rebates

¶20-040

Recognition of prior learning (RPL)

¶8-265

Record keeping car fringe benefits

¶3-410

car parking benefits

¶3-420

CGT

¶2-530

— topical checklist

¶2-700

duty to give quality advice — best practice — licensees

¶8-130

FBT exemption

¶3-800

financial advisers

¶8-130

home office running expenses

¶12-066

Record of Advice (RoA)

¶8-315

Recouped expenditure

¶2-200

Reductions in fringe benefits tax — see also Fringe benefits tax (FBT) salary packaging

¶10-000

— employee contributions reducing FBT

¶10-610

— exempt and rebatable employers

¶10-620

— expatriate and visiting overseas employees

¶10-670

— increased savings from reduced FBT

¶10-600

— otherwise deductible rule

¶10-630

— remote area benefits

¶10-650

Redundancy, early retirement and invalidity — see Genuine redundancy and early retirement scheme Refugees social security benefits, waiting period

¶6-750

Refundable Accommodation Contributions (RAC)

¶17-340

Refundable Accommodation Deposit (RAD)

¶17-340

Regional Assessment Service (RAS) assessment and access of CHSP Registered religious institution (RRI)

¶17-110 ¶3-650

Registrable superannuation entities (RSEs) licensing

¶4-150; ¶8-020

Regulation of financial services — see also Compliance; Financial advisers compliance

¶8-000

disclosure to clients

¶8-290

— Financial Services Guide (FSG)

¶8-300

— Product Disclosure Statement (PDS)

¶8-320

— Record of Advice (RoA)

¶8-315

— Statement of Advice (SoA)

¶8-310

financial products

¶8-220

— advice

¶8-230

general obligations

¶8-280

licensing

¶8-250

— training of financial product advisers

¶8-265

providing advice on SMSFs

¶5-800

restricted terminology

¶8-270

retail or wholesale clients

¶8-240

when to provide financial services

¶8-230

Reinvestment dividend reinvestment plans

¶2-205

Relationship breakdown capital gains tax — other exemptions or loss-denying transactions — relationship breakdown settlements

¶2-343

superannuation — split

¶4-480

Remote area housing fringe benefits

¶3-700

remote area home ownership schemes

¶3-700

salary packaging

¶10-650

Renewal notice fee disclosure statement

¶8-155

Rent Assistance

¶6-340

Rental income assessable income deceased estate tax returns

¶1-270 ¶19-910

deductible expenses

¶1-325

direct property investment

¶9-316

income test

¶6-660

main residence

¶12-300

— taxation implications of Airbnb

¶12-350

Rental property income test strategies

¶6-840

main residence

¶12-300

— GST

¶12-084

— taxation implications of Airbnb

¶12-350

Repairs deductible expenses main residence

¶1-325 ¶12-083

Repatriation Health Cards Gold Card

¶6-480

White Card Reportable employer superannuation contributions (RESCs) Reportable fringe benefits

¶6-480 ¶3-155; ¶4-215; ¶4-220 ¶3-155; ¶3-650; ¶10-030

— see also Fringe benefits impact on other tax concessions

¶3-900

interaction between income tax and FBT

¶1-090

Research and development, deductions

¶1-340

Reserve Bank of Australia (RBA)

¶11-350

Reserves self managed superannuation funds

¶5-700

Residency self managed superannuation funds

¶5-110

social security allowances

¶6-185

social security pensions

¶6-135

tax consequences

¶1-550

Residential aged care ACAT assessment

¶17-320

costs, calculating

¶17-340

entering care

¶17-330

entry process

¶17-310

— facilities

¶17-300

— facilities, changing

¶17-360

— family home and

¶17-350

financial hardship assistance for

¶17-380

low level and high level care

¶17-320

respite care — assessment for

¶17-370

— cost of

¶17-370

Residential property investments geared investment projections

¶9-310 ¶11-550

Residential qualifications for allowances payments while overseas Resident non-occupying owners, taxes imposed on

¶6-185

on absentee owners

¶12-058

land tax

¶12-057

Resident trust capital gains and losses

¶2-280

Residents income tax — foreign income

¶1-550 ¶1-550–1-580

— overseas investments

¶1-565

— source of income

¶1-555

income tax rates

¶20-010

— minors

¶20-035

loss of Australian residency

¶2-110

overseas residents — compulsory HELP repayments

¶13-415

Residual capital value of income streams

¶16-200

Residual fringe benefits

¶3-200

Restricted non-preserved benefits — see Superannuation funds Restricted trusts

¶19-300

administration

¶19-310

application of trust fund

¶19-310

control

¶19-305

death of beneficiary

¶19-315

surplus income

¶19-310

trustee, selection

¶19-305

Restrictive trade practices

¶8-415

Retail clients financial services

¶8-240

the exam

¶8-265

wholesale advice by FASEA

¶8-240

Retirement incomes annuity or pension

¶16-000; ¶17-000 ¶16-130

income in retirement — income needs

¶16-115

— key objective of retirement planning

¶16-100

— longevity risk with frailty risk

¶16-110

— self managed superannuation funds

¶16-148

— social security (Centrelink)

¶16-120

— use of income streams

¶16-130; ¶16-195

income streams, death benefits

¶16-900

— child account-based pensions

¶16-930

— commutation

¶16-920

— taxation

¶16-910

— transfer balance caps

¶16-940

income streams, maximisation

¶16-600

— changing income stream providers

¶16-640

— social security

¶16-620

— strategies to minimise aged care fees

¶16-630

— transition to retirement and salary sacrifice strategy

¶16-610

income streams, taxation

¶16-700–16-810

income streams, transfer balance cap — assessment

¶16-155

— capped defined benefit income streams

¶16-180

— commencement

¶16-150

— tax on excess amount

¶16-170

income streams, types — account-based pensions — categorization

¶16-500–16-540 ¶16-190

— fixed term income streams

¶16-200–16-260

— lifetime income streams

¶16-300–16-360

— longevity and CIPRs — term allocated pensions (TAPs) retirement income covenant

¶16-570 ¶16-400–16-440 ¶16-135

retirement portfolio construction — income splitting

¶16-589

— investment options

¶16-587

— making income stream payments

¶16-575

— portfolio strategies

¶16-580

— transition to retirement rules

¶16-585

review of

¶16-137

social security and aged care assessment

¶16-590

— account-based pension

¶16-591

— deductible amount rules

¶16-598

— fixed term income stream

¶16-592

— lifetime income stream

¶16-593

— term allocated pension

¶16-596

superannuation income streams — see Superannuation income streams Retirement living

¶17-010

accommodation options for ageing clients

¶17-020

aged care

¶17-000

— financial hardship assistance

¶17-380

downsizing — social security

¶17-025

financial advice, value of — entering residential care

¶17-015

— steps prior to residential care

¶17-015

granny flats interests — establishment of

¶17-030

— granny flat arrangement

¶17-030

— social security means-test assessment of

¶17-030

— value of, determined

¶17-030

home care — Commonwealth Home Support Programme (CHSP)

¶17-110

— home care packages (HCP)

¶17-120

— receiving services and support

¶17-100

independent living arrangements — independent living units — retirement villages — Supported Residential Services (SRS) retirement villages

¶17-230 ¶17-200; ¶17-210 ¶17-220 ¶17-200; ¶17-210

— social security assessment and costs of

¶17-240

Retirement planning

¶15-000

building capital base

¶15-010

compounding returns, power

¶15-015

gearing strategies

¶11-500

genuine redundancy and early retirement scheme payments

¶20-110

housing in retirement income — see Retirement incomes

¶6-560

key objective of retirement planning

¶16-100

main residence

¶12-700

— home reversion scheme

¶12-700

— reverse mortgages

¶12-700

other planning issues — accepting the fact of retirement

¶15-530

— budgeting

¶15-540

— consolidation of superannuation benefits

¶15-510

— estate planning

¶15-590

— financial and lifestyle

¶15-520

— health issues

¶15-560

— insurance

¶15-580

— where to live

¶15-570

reasons for planning

¶15-005

retirement, definition

¶15-400

risk return

¶15-017

small business CGT concessions

¶15-210

superannuation

¶15-020

— alternative investment strategies

¶15-035

— comparison of superannuation and non-superannuation

¶15-040

— consolidation of benefits

¶15-510

— contributions

¶15-045–15-195

— preservation of benefits

¶15-400

— small business and superannuation

¶15-200

— tax advantages

¶15-025

time horizons

¶15-017

Retirement portfolio construction making income stream payments

¶16-575

portfolio strategies — bucket approach

¶16-580

— income layering

¶16-580

Retirement savings accounts (RSAs) definition

¶4-120

Retirement villages

¶17-210

social security assessment and costs of

¶17-240

Returns domestic equities

¶9-275

geared investments

¶11-000

— maximising after-tax returns

¶11-255

Revenue losses CGT — re-characterising capital losses as revenue losses Reverse mortgages income and assets test

¶2-650 ¶12-700 ¶6-660

Reversionary beneficiary death benefits

¶19-610

lifetime income streams

¶16-330

Reversionary bonuses assessable income Reversionary income streams Rippoll inquiry

¶1-275 ¶16-598 ¶8-020

Risk assessment investment asset classes

¶9-070

investment performance

¶9-720

Risk return retirement planning — investment

¶15-017

Roll-overs CGT

¶2-400; ¶2-600

— compulsory acquisition

¶2-410

— deferring

¶2-400

— family breakdown — foreign interest holders — main residence on family breakdown

¶2-410; ¶18-505 ¶2-410 ¶12-200–12-215

— replacement-asset roll-over

¶2-410

— reversal of roll-overs

¶2-110

— same-asset roll-over

¶2-410

— small business concessions

¶2-339

— transfer from company/trust

¶18-505

excess untaxed amount

¶4-430

small business restructure roll-over

¶2-410

superannuation benefits superannuation fund

¶1-285; ¶4-430 ¶4-232

Royalties withholding tax — rates

¶1-150

S Salary and wages deceased's returns

¶19-910

salary packaging — see Salary packaging Salary packaging

¶10-000

basics — benefits of salary sacrifice

¶10-060

— definition

¶10-010

— effective salary sacrifice arrangements

¶10-050

— employee considerations

¶10-030

— employer considerations

¶10-020

— total employment cost

¶10-040

case studies

¶10-700–10-740

excluded benefits — employee share schemes

¶10-470

— salary sacrifice into superannuation

¶10-430

exempt fringe benefits

¶10-500

— frequent flyer benefits

¶10-530

— in-house child care

¶10-540

— laptops and work-related equipment

¶10-520

— long service awards

¶10-550

— other exempt benefits

¶10-570

reductions in FBT — employee contributions reducing FBT

¶10-610

— exempt and rebatable employers

¶10-620

— expatriate and visiting overseas employees

¶10-670

— increased savings from reduced FBT

¶10-600

— otherwise deductible rule

¶10-630

— remote area benefits

¶10-650

tax rules — basic tax rules

¶10-200

— interaction of FBT and income tax

¶10-240

— salary sacrificed benefits

¶10-260

taxable fringe benefits

¶10-300

— car parking

¶10-320

— cars (motor vehicles)

¶10-310

— living-away-from-home allowance

¶10-350

— loans

¶10-340

— meal entertainment

¶10-370

Salary packaging arrangement (SSA) Salary packaging or sacrifice arrangements

¶3-850 ¶10-050; ¶10-430

employer contributions

¶4-210

— consequences

¶4-215

— following salary sacrifice

¶4-215

FBT

¶1-090; ¶3-850

interaction between income tax and FBT — salary sacrifice

¶1-090

salary packaging

¶10-000

— benefits of salary sacrifice

¶10-060; ¶10-260

superannuation contributions — non-commutable pension strategy

¶15-110

— non-superannuation investments, comparison

¶15-040

— retirement planning

¶15-100

transition to retirement

¶16-610

Salary sacrificed superannuation contributions

¶10-040

compulsory SG contributions

¶10-430

Same sex couples family breakdown

¶18-000

— Family Court

¶18-010

Scholarship (education) funds

¶13-330

School fees — see Education costs Scrip-for-scrip roll-over — see Roll-overs

Seasonal Work Preclusion Period Sector rotation

¶6-050; ¶6-190; ¶6-240; ¶6-250 ¶21-630

Secured loans borrowing

¶11-330

Securities — see also Domestic equities assessable disposal or redemption

¶1-275

hybrid securities

¶9-350

taxing point of conversion or exchange

¶1-275

Self-assessment of income tax objection

¶1-060; ¶1-705 ¶1-710

Self-employed or substantially self-employed persons deductible expenses personal superannuation contributions

¶1-320 ¶15-050

— deduction

¶4-220

— government co-contributions

¶4-265

Self-employment sufficient work test Self managed superannuation funds (SMSFs)

¶6-190 ¶5-000; ¶5-010

benefits

¶5-040

complying fund

¶4-310

death benefits definition disadvantages

¶4-425; ¶16-900; ¶19-365 ¶4-110; ¶5-020 ¶5-050

establishing — active members

¶5-110

— basic requirements

¶5-100

— central management and control

¶5-110

— duties of trustees

¶5-110

— non-complying SMSFs

¶5-110

— residency status

¶5-110

event-based reporting

¶5-205

fund accounts — annual returns

¶5-225

— contribution

¶5-350

— market value reporting

¶5-210

— member accounts

¶5-200

— pooled or separated investment accounts

¶5-220

income streams

¶16-148

— tax (commenced from 1 July 2007)

¶16-710

income tax — complying income streams

¶16-840

instalment warrants

¶9-340

investment rules

¶5-310

— acquisition of assets

¶5-350

— acquisition of real estate by SMSF

¶5-500

— all transactions to be on arm's length

¶5-380

— borrowing in limited circumstances

¶5-360

— in-house assets test

¶5-330

— investment strategy

¶5-400

— providing advice

¶5-800

— reserves

¶5-700

— sole purpose test

¶5-320

— taxation

¶5-600

— trust deed

¶5-310

— trustee not to charge assets of the fund

¶5-390

— trustee not to lend to members

¶5-370

limited recourse borrowing arrangements

¶8-220

regulations

¶4-150

retirement incomes

¶16-148

trustees’ obligations

¶5-050

2018 Budget proposed changes to

¶5-060

Senior Australians Medicare levy Seniors Supplement tax offsets Senior Australians and pensioners tax offset (SAPTO)

¶20-020 ¶6-360 ¶1-355; ¶20-043 ¶1-355; ¶8-350; ¶20-043

Seniors Supplement

¶6-360

Separately Managed Accounts (SMAs)

¶9-610

Service Pensions — see Pensions

Services Australia

¶6-050

assessment of the MTF

¶17-340

child support or child maintenance

¶13-800

child support scheme

¶13-805

government family payments

¶13-700

income tested fee calculation

¶17-120

JobSeeker Payment recipients

¶6-190

paid parental leave — pregnancy related complications

¶13-705

retirement living and aged care

¶17-000

taxable pensions or payments

¶13-605

SG amnesty

¶4-500

employers to correct underpayments

¶4-560

Share buy-backs

¶2-110

Share futures

¶9-335

geared investments

¶11-800

Share markets — see Domestic equities Share Price Index (SPIs) futures

¶9-335

Share trading clubs websites

¶21-140

Share transfers family breakdown

¶18-505

Shareholders CGT non-assessable payments

¶2-205

re-characterising capital losses as revenue losses

¶2-650

return of capital

¶2-205

Shares — see also Domestic equities CGT

¶2-110

— cost base

¶2-205

— non-assessable payments

¶2-205

— topical checklist

¶2-700

CGT roll-over — foreign interest holders deceased estates

¶2-410 ¶19-910

— tax rules direct property investments, distinguished

¶19-620 ¶9-316

geared investment projections

¶11-550

geared share managed funds

¶11-600

instalment warrants

¶11-700

margin lending

¶11-350; ¶11-355

options — see Options profit on sale retirement incomes

¶1-280 ¶16-587

value shifts

¶2-205

Short-term money markets

¶9-130

Shortfall exemption certificate

¶4-000

Shortfall interest charge (SIC)

¶1-750

Sickness Allowance Single Touch Payroll (STP) system

¶6-190; ¶20-540 ¶1-090; ¶4-510

salary packaging

¶10-010

Services Australia

¶6-050

Small APRA fund (SAF) income tax — complying income streams Small business CGT concessions active assets CGT concession stakeholder

¶16-840 ¶1-295 ¶2-300; ¶2-310; ¶2-320 ¶2-310; ¶2-325

disposal of assets

¶1-295

15-year asset exemption

¶2-336

50% active asset exemption

¶2-337

flowchart

¶2-300

look-through earnout rights

¶2-345

maximum net asset value test

¶2-300; ¶2-315

passively held assets

¶2-310

replacement asset roll-over

¶2-339

retirement exemption

¶2-338

retirement issues roll-over relief

¶15-210 ¶2-410

significant individual test

¶2-323

small business entity test

¶2-310

Small business entities accelerated depreciation deductions

¶1-283

assessable income

¶1-283

instant asset write-off

¶1-330

Small businesses CGT concessions — additional basic conditions

¶2-300

— general rules and approach

¶2-300

CGT topical checklist

¶2-700

depreciating assets

¶1-330

exempt car parking benefits

¶3-200

income tax offset restructure roll-over tax offset

¶20-075 ¶2-410 ¶1-283; ¶1-355

Small employers ATO concessions

¶4-510

Small superannuation funds definition

¶4-110

marriage breakdown — transfer of interest SMSF Association (SMSFA)

¶18-400 ¶8-155

SMSF members remains government policy

¶4-110

SMSF Professionals’ Association of Australia (SPAA)

¶8-155

SMSF trustees limited licensing regime

¶8-250

Social distancing due to COVID-19 Social security assessment former home retirement income

¶8-265 ¶16-590 ¶17-240; ¶17-330

— account-based pension

¶16-591

— deductible amount rules

¶16-598

— fixed term income stream

¶16-592

— lifetime income stream

¶16-593

— term allocated pension

¶16-596

Veterans’ Affairs

¶16-590

Social security benefits

¶6-000

aged care

¶20-580

allowances, maximum benefit entitlement

¶20-470

assessment of investments

¶6-580

— financial assets and deeming

¶6-600

— gifting rules

¶6-670

— income streams

¶6-640

— private trusts and companies

¶6-620

— property investments, treatment

¶6-660

— rules

¶6-580

— superannuation

¶6-610

Centrelink benefits

¶6-100; ¶6-360

— Age Pension

¶6-140

— Austudy and Youth Allowance

¶6-250

— Bereavement Payments

¶6-290

— Carer Allowance

¶6-170

— Carer Payment

¶6-160

— change of circumstances

¶6-120

— Commonwealth Seniors Health Card (CSHC)

¶6-360

— deeming of account-based pensions

¶6-360

— Disability Support Pension (DSP)

¶6-180

— Double Orphan Pension

¶6-300

— eligibility

¶6-360

— energy supplement

¶6-360

— Family Assistance payments

¶6-350

— family breakdown

¶18-705

— Health Care Card

¶6-360

— intent to claim

¶6-100

— JobSeeker Payment

¶6-190

— low income test

¶6-360

— Mobility Allowance

¶6-300

— online services

¶6-100

— Parenting Payment

¶6-240

— Partner Allowance

¶6-230

— Pension Bonus Scheme (PBS)

¶6-320

— Pensioner Concession Card

¶6-360

— Rent Assistance

¶6-340

— residential qualification for pensions

¶6-135

— residential qualifications for allowances

¶6-185

— Seniors Health Card income test

¶6-360

— Special Benefit

¶6-300

— summary of other pensions and allowances

¶6-300

— taxation of benefits

¶6-310

— telephone allowance

¶6-360

— Widow Allowance

¶6-270

deceased estates Department of Veterans’ Affairs benefits

¶19-960 ¶6-400–6-480

dependants of deceased

¶19-960

effect of death to other taxes and benefits

¶19-960

Family Tax Benefits (FTB) — family financial planning

¶13-710–13-720

— income test

¶13-725

— Part A — income test limits

¶20-572

— Part A — rates

¶20-570

— Part B — income test

¶20-574

— Part B — rates

¶20-574

— Part B — Supplement

¶20-574

grandparents paying school fees to grandchild

¶13-355

housing in retirement — pensions, assets test and family home

¶6-560

income and assets test

¶6-500

— allowances

¶20-540

— assets test

¶6-520

— family home exemption

¶6-560

— home owners — income test

¶20-550 ¶6-540

— non-home owners

¶20-560

— pensions

¶20-530

— strategies income maintenance period

¶6-800–6-860 ¶14-430

income streams — maximising strategies

¶16-620

JobSeeker Payment

¶14-430

liquid assets waiting period

¶14-430

new and proposed changes — changes to parental leave pay

¶6-050

— changes to reporting employment income delayed

¶6-050

— economic support payments to COVID-19

¶6-050; ¶6-140; ¶6-160; ¶6-170; ¶6-180

— farm household allowance extended

¶6-050

— income support payments due to COVID-19

¶6-050

— JobKeeper Payment

¶6-050

— proof of life certificate for 80+ year olds living overseas

¶6-050

— Services Australia

¶6-050

paid parental leave — scheme pensions, maximum benefit entitlement senior Australians and pensioners tax offset

¶20-578 ¶6-350 ¶20-460 ¶1-355

SRS

¶17-220

termination of employment

¶14-430

waiting or non-payment periods

¶6-000

waiting periods — compensation

¶6-710

— income maintenance

¶6-730

— liquid assets

¶6-720

— newly arrived residents

¶6-750

— ordinary waiting period

¶6-705

— rules

¶6-700

Social security deductible amount rules impact of commutations

¶16-598

reversionary income streams

¶16-598

Social security implications income in retirement — social security (Centrelink) in retirement maximising retirement income — strategies

¶16-120

— maximising income in fixed term and lifetime income streams

¶16-600

taxation issues — children's income

¶13-625

transfer balance cap — income stream commencement

¶16-150

Socially responsible investments (SRIs)

¶9-370

Sole purpose test

¶5-320

Sole trader business succession

¶19-800

turnover reduction due to COVID-19

¶6-050

Special Benefit Allowance

¶6-050

NARWP

¶6-750

Special disability trusts (SDTs) family financial planning

¶2-250; ¶6-620; ¶19-300 ¶13-510

Special value capped defined benefit income streams — calculation

¶16-180

Specialist assets

¶9-320

asset allocation

¶9-380

collectables

¶9-365

commodities

¶9-330

cryptocurrency

¶9-375

derivatives

¶9-335

hedge funds

¶9-345

hybrid securities

¶9-350

infrastructure

¶9-325

investment management styles

¶9-400

other types of investments

¶9-320

private equity

¶9-355

socially responsible investments (SRIs)

¶9-370

tax-effective investments

¶9-360

warrants

¶9-340

Spouse contributions legal or de-facto spouse

¶4-205; ¶15-000; ¶15-190 ¶15-192

tax offset

¶4-200

Spouses income splitting

¶16-589

maintenance

¶18-700

rebates superannuation contributions

¶1-355 ¶15-190

— assets test strategies

¶6-860

— contributions splitting

¶4-260; ¶15-192

— offset

¶4-275; ¶20-330

— retirement planning

¶15-190

Stamp duty family breakdown

¶18-600

— main residence

¶18-605

Statement of Advice (SoA)

¶8-010; ¶8-130; ¶8-310

State-sponsored lockdowns, COVID-19

¶8-265

Stepped premiums

¶7-905

Stock and market news websites

¶21-150

Stock filters websites

¶21-230

Student Start-up Loan — see Austudy Students Austudy

¶6-250

contribution option

¶13-405

HELP

¶20-080

Substantiation work-related expenses

¶1-320

Superannuation

¶4-000

accounts — advice fees to superannuation members

¶8-155

— deduction of any advice fee

¶8-155

alternative investment strategies to superannuation assets test strategies

¶15-035 ¶6-860

comparison of superannuation and non-superannuation complaints for insurance inside superannuation contributions

¶15-040 ¶7-985 ¶1-320; ¶4-200

— acceptance

¶4-205

— Commissioner's discretion

¶4-250

— debits to transfer balance account

¶4-228

— downsizer contributions

¶4-223

— employer contributions

¶4-000; ¶4-210

— employer contributions following salary sacrifice

¶4-215

— excess concessional contributions

¶4-234

— excess non-concessional contributions

¶4-240; ¶4-245

— excess transfer balance determinations

¶4-230

— excess transfer balance tax

¶4-231

— first home super saver

¶4-222

— government co-contributions

¶4-265

— low income superannuation tax offset

¶4-270

— made to a fund

¶4-203

— penalties imposed on excess concessional contributions

¶4-235

— personal contributions

¶4-220

— splitting

¶4-260

— tax of high income earners

¶4-225

— tax offsets for spouse contributions

¶4-275

— taxation

¶4-280

— total superannuation balance

¶4-233

— transfer balance account

¶4-228

— transfer balance cap rules — transfer balance cap rules for capped and defined benefit income streams death benefits downsizer contributions family breakdown first home super saver scheme financial product advice

¶4-227; ¶4-229 ¶4-232 ¶19-405 ¶4-223 ¶18-105 ¶4-222 ¶8-250; ¶8-260

foreign — Australian or foreign funds

¶4-600

— benefits from foreign funds

¶4-650

in Australia — interaction with bankruptcy laws

¶4-160

— objectives of superannuation

¶4-100

— other superannuation entities

¶4-120

— regulations

¶4-150

— superannuation funds

¶4-110

life insurance inside superannuation

¶7-800

— cross-insurance and self-managed funds

¶7-870

— funding premiums

¶7-840

— insurance in super and low-balance or inactive accounts

¶7-890

— meeting the sole purpose test

¶7-830

— non-business reasons, advantages and disadvantages

¶7-820

— reserving strategies

¶7-880

— structure

¶7-810

— tax deductions for premiums

¶7-850

— taxation of insurance

¶7-860

modified transfer balance cap rules

¶19-405

need for access flexibility

¶15-025

online investments — lost accounts online searching

¶21-540

— online investment resources

¶21-540

— online managed funds investment resources

¶21-500–21-540

payment of child pension

¶19-405

personal contributions

¶15-020

retirement planning

¶15-000

— consolidation of benefits

¶15-510

— preservation rules

¶15-400

— salary sacrifice or deductible contributions

¶15-040

— salary sacrifice versus non-superannuation investment strategy

¶15-040

— tax advantages social security assessment of investments Superannuation Complaints Tribunal

¶15-020; ¶15-025 ¶6-610 ¶21-540

superannuation guarantee scheme

¶4-500

— choice of fund rules

¶4-580

— employees covered

¶4-520

— employer contributions

¶4-540

— liability to charge if insufficient contributions

¶4-560

— quarterly payment

¶4-510

superannuation proceeds trust

¶19-405

taxation

¶4-300; ¶4-310

— complying funds

¶4-320

— no-TFN contributions income

¶4-390

— non-complying funds

¶4-340

— PSTs

¶4-360

withdrawal of benefits

¶4-400

— benefits paid to a member

¶4-420

— death benefits

¶4-425

— income streams commencing before 1 July 2007

¶4-450

— preservation

¶4-400

— roll-over of payments

¶4-430

— split on relationship breakdown

¶4-480

— transfer, between Australia and New Zealand

¶4-440

Superannuation benefits

¶4-400

death benefits

¶4-425; ¶20-305

disposal — proposed superannuation benefits for downsizing

¶12-710

former temporary residents’ rights

¶4-435

from foreign funds

¶4-650

payment

¶4-420

tax free component

¶4-420

taxable component

¶4-420

taxation

¶4-420; ¶15-020; ¶20-300

Superannuation Complaints Tribunal (SCT) external dispute resolution

¶4-150; ¶8-615

Superannuation contribution caps life benefit termination payments

¶14-425

Superannuation contributions

¶4-200; ¶5-350

acceptance

¶4-205

bankrupt members

¶4-160

concessional contributions cap contributions splitting downsizer contributions

¶20-310 ¶4-210; ¶4-260; ¶15-192 ¶4-223; ¶15-198

employer contributions — age-related conditions

¶4-205

— deductions

¶4-210; ¶4-215

— following salary sacrifice

¶4-215

— non-complying

¶4-210

— voluntary contributions

¶4-210

excess concessional contributions

¶4-234

— Commissioner's discretion

¶4-250

— penalties imposed

¶4-235

first home super saver scheme

¶4-222

fringe benefits

¶3-600

— reportable employer superannuation contributions

¶3-155

generating income government co-contributions income splitting low income tax offset

¶16-587 ¶4-265; ¶15-195; ¶20-340 ¶16-589 ¶4-270

non-concessional contributions cap

¶20-320

— bring forward arrangement

¶20-320

personal contributions — age-related conditions

¶4-205

— deductions

¶4-220

— downsizer contributions — government co-contributions

¶4-223; ¶15-198 ¶4-265; ¶15-195; ¶20-340

— notice requirements

¶4-220

— pre-2017/18 deduction condition — 10% rule

¶4-220

retirement planning

¶15-045

— concessional contributions

¶15-050

— downsizer contributions

¶15-198

— first home super saver scheme

¶4-222

— government co-contributions

¶15-195

— maximising tax-free component

¶15-180

— non-concessional contributions

¶15-048

— re-contribution strategy

¶15-180

— salary sacrifice

¶15-100

— spouse contribution splitting

¶15-192

— spouse contributions

¶15-190

— transitioning to retirement

¶15-110

salary packaging

¶10-430

salary sacrifice into superannuation

¶10-430

saving for children's education

¶13-350

spouse contributions

¶15-190

— offsets

¶4-275; ¶20-330

— test strategies

¶6-860

taxation

¶4-280

— fund

¶4-320

total superannuation balance

¶4-233

transfer balance cap rules

¶4-227

Superannuation entities

¶4-120

funds

¶4-110

interaction with bankruptcy laws

¶4-160

regulations

¶4-150

taxation of funds

¶4-300

Superannuation funds

¶4-110

accumulation and retirement phases

¶4-233

Australian or foreign superannuation funds

¶4-600

bequest of property

¶19-755

cashing of benefits

¶15-400

CGT

¶4-320

choice of fund — see Superannuation guarantee (SG) scheme consolidation of benefits contribution

¶15-510 ¶4-200; ¶5-350

— acceptance

¶4-205

— Commissioner's discretion

¶4-250

— debits to transfer balance account

¶4-228

— downsizer contributions

¶4-223

— employer contributions

¶4-210

— employer contributions following salary sacrifice

¶4-215

— excess concessional contributions

¶4-234

— excess non-concessional contributions

¶4-240; ¶4-245

— excess transfer balance determinations

¶4-230

— excess transfer balance tax

¶4-231

— first home super saver

¶4-222

— government co-contributions

¶4-265

— low income superannuation tax offset

¶4-270

— made to a fund

¶4-203

— penalties imposed on excess concessional contributions

¶4-235

— personal contributions

¶4-220

— splitting

¶4-260

— tax of high income earners

¶4-225

— tax offsets for spouse contributions

¶4-275

— taxation

¶4-280

— total superannuation balance

¶4-233

— transfer balance account

¶4-228

— transfer balance cap rules — transfer balance cap rules for capped and defined benefit income streams

¶4-227; ¶4-229 ¶4-232

death benefits — adjusting beneficiary entitlement

¶19-115

— binding death benefit nominations

¶19-365

— estate planning

¶19-365

— tax rules

¶19-610

distributions by trusts

¶1-505

family breakdown — binding death benefit nominations — splitting of superannuation interests

¶18-205 ¶4-480

— splitting superannuation

¶18-200

— superannuation agreement

¶18-200

— taxation

¶18-400

first home super saver scheme

¶4-222

former temporary residents — superannuation benefits

¶4-435

gearing investments

¶11-520

— instalment warrants

¶11-700

income tax

¶4-300–4-390

— complying funds

¶4-320

— complying/non-complying status

¶4-310

— contributions

¶4-280

— no-TFN contributions income

¶4-390

— non-arm’s length income

¶4-320

— non-complying funds

¶4-340

— PSTs

¶4-360

— rates

¶20-060

— superannuation benefits

¶4-420; ¶4-425

— superannuation income streams before 1 July 2007

¶4-450

non-complying — employer contributions

¶4-210

— fringe benefits

¶3-600; ¶4-210

— income tax

¶4-310; ¶4-340

— prohibited refund of excess imputation credits

¶1-405

non-complying Australian funds — taxation of income streams

¶16-810

overseas funds — see Foreign superannuation funds pensions — see Superannuation pensions preservation rules — retirement planning

¶15-400

— withdrawal of benefits

¶4-400

regulations

¶4-150

retirement planning — preservation rules

¶15-400

roll-over superannuation benefits

¶4-430

withdrawal of benefits

¶4-400

Superannuation guarantee (SG) contributions

¶4-000

employees with multiple employers

¶4-520

ordinary time earnings

¶4-540

salary sacrificed superannuation contributions Superannuation guarantee (SG) scheme

¶10-040 ¶4-500

charge — charge percentage — maximum contribution base

¶4-540; ¶20-400 ¶20-410

— obligations

¶4-560

choice of fund rules

¶4-580

— online superannuation resources

¶21-540

contractors

¶4-520

employees

¶4-520

employer's level of support — increase

¶4-540

mandated employer contributions

¶4-205

quarterly payments

¶4-510

Superannuation income streams — see also Income streams

Superannuation pensions account-based income streams

¶16-145; ¶16-190

— minimum annual pension payment percentages

¶20-240

budget repair levy

¶1-290

categories

¶16-130; ¶16-190

commencement

¶16-150

comparison

¶16-195

income tax before 1 July 2007

¶4-450

Medicare levy

¶1-290

non-account based income streams

¶16-145; ¶16-190

non-commutable income streams

¶16-585

retirement income covenant

¶16-135

retirement incomes

¶16-130

self managed superannuation funds

¶16-148

taxation

¶1-290; ¶4-420; ¶4425

transition to retirement rules

¶16-585

— pensions and transfer balance cap

¶16-585

— and salary sacrifice strategy

¶16-610

Superannuation lump sums disability benefit calculation

¶14-330

income tax

¶1-285

— taxed and untaxed source

¶1-285

taxation of benefits

¶4-420; ¶4-425

Superannuation or ordinary money annuities

¶16-130

Superannuation pensions — see also Pensions; Superannuation income streams death benefits — child beneficiary

¶19-115; ¶19405

life expectancy factors

¶20-250

non-commutable income streams

¶15-110

relationship breakdown

¶4-480

Superannuation supervisory levies

¶4-150

Supplement, COVID-19

¶6-050; ¶6-190; ¶6-240; ¶6-250; ¶20-470

Supported Residential Services (SRS)

¶17-200

Supportive attorney

¶19-455

Surcharge additional taxes on foreign resident owners — land tax absentee owner surcharge

¶12-075

— stamp duty surcharge

¶12-075

Medicare levy Surplus cash flow

¶1-075; ¶20-025 ¶13-340

T Tax agent service

¶8-350

Tax avoidance

¶1-600

administrative penalties

¶1-755

distribution washing provisions

¶1-607

general anti-avoidance provisions

¶1-610

specific anti-avoidance provisions

¶1-605

transfer pricing

¶1-615

Tax benefits anti-avoidance provisions

¶1-610

Tax concessions Australian film investment

¶9-360

estate planning — estate proceeds trust

¶19-410

— superannuation proceeds trust

¶19-405

— taking advantage of rules for minors

¶19-400

genuine redundancy and early retirement scheme

¶14-220–14-260

— invalidity payments

¶14-300–14-320

— overview

¶14-110

superannuation funds

¶4-300

— complying status

¶4-310

— retirement planning

¶15-020

Tax deductions — see Deductions Tax-effective investments

¶9-360

Tax file numbers (TFNs)

¶15-050

children's trust income

¶13-620

exempt rules

¶1-115

income streams

¶16-730

quotation rules

¶1-115

self managed superannuation funds

¶5-100

superannuation funds

¶4-200

Tax losses

¶1-065

CGT record-keeping

¶2-530

family breakdown

¶18-305

Tax offsets — see also Rebates CGT exemption

¶2-270

concessional offsets

¶1-355

cross-border issues — foreign income tax offset income streams investments in early stage innovation company (ESIC) low income earners outline

¶1-575 ¶16-770 ¶1-355 ¶1-355; ¶20-045 ¶1-350

personal superannuation contributions — low income or non-working spouse

¶4-275

private health insurance tax offset

¶1-355

senior Australians and pensioners

¶1-355; ¶20-043

small business income tax offset

¶1-355

for spouse contributions

¶4-200

spouse superannuation contributions

¶15-190

unused annual leave payments

¶14-230

unused long service leave payments

¶14-240

Tax payable

¶1-055

Tax Practitioners Board (TPB)

¶8-010

Tax rates — see Income tax rates Tax-related advice financial planners

¶8-350

offences

¶8-350

overview of notification, transitional and standard options

¶8-350

TPB Code of Professional Conduct information sheets

¶8-350

Tax-related expenses deceased estates Tax returns

¶19-910 ¶1-700

deceased estates — date-of-death or terminal

¶19-900

— estate returns for period after death

¶19-905

— timing issues for date of death v estate return

¶19-910

Taxable Australian property (TAP)

¶2-280

Taxable fringe benefits

¶10-300

salary packaging

¶10-000

— car parking

¶10-320

— cars (motor vehicles)

¶10-310

— living-away-from-home allowance

¶10-350

— loans

¶10-340

— meal entertainment

¶10-370

Taxable income

¶1-050

annual basis of taxation

¶1-250

assessments

¶1-705

gearing

¶11-200

tax payable

¶1-055

unearned income of minors

¶1-070

Taxable values car parking fringe benefit

¶3-420

employee

¶3-450

FBT

¶3-400; ¶3-500

Taxation Rulings

¶1-650

binding on Commissioner

¶1-660

contributions made to superannuation funds

¶4-203

duties of trustees

¶5-110

earnout rights

¶2-350

employee benefits trusts

¶3-200

employment fringe benefits

¶3-100

expense payment fringe benefits

¶3-430

home loan unit trust schemes

¶12-100

in-house child care

¶10-540

negative gearing

¶11-200

objection and review of private ruling

¶1-665

residual fringe benefits

¶3-200

salary packaging salary packaging or sacrifice salary sacrifice arrangements scope

¶10-200 ¶3-850 ¶10-050; ¶15-100 ¶1-650

self managed superannuation funds — duties of trustees

¶5-110

— obligations on trustees

¶5-050

split loans

¶12-110

superannuation deductible expenses

¶4-320

taxation of investments in the fund

¶5-600

Taxi defined

¶3-600

licensed to operate as a taxi

¶3-600

Taxpayer liable to excess transfer balance tax

¶4-228

Taxpayer alerts

¶1-650

CGT — alienation of income

¶2-650

— artificially creating capital losses through default beneficiary arrangement

¶2-650

— avoidance using a trust structure

¶2-650

— re-characterising capital losses as revenue losses

¶2-650

— trust and taxable income mismatches

¶2-650

family home — interest deduction generators

¶12-110

fringe benefits tax — superannuation contributions for employees

¶3-600

Technical analysis online investing — benefits

¶21-300

— charting tools set up

¶21-310

— complementing with fundamental data

¶21-320

— tip sheets

¶21-330

Telephone allowance

¶6-360

Temporary residents CGT — concessions

¶2-280

— exemptions and withholding tax

¶2-280

superannuation benefits — former temporary residents

¶4-435

— who has not left Australia

¶4-435

Tenants in common capital gains or losses

¶2-220

Term allocated pensions (TAPs)

¶16-400

advantages and disadvantages

¶16-440

assets test assessment

¶16-596

comparison of income streams

¶16-195

income payments

¶16-410

income test assessment

¶16-596

Life Expectancy Tables

¶20-250

payment factors

¶20-270

Term deposits

¶9-140

saving for children's education Term insurance policies

¶13-315 ¶7-055

Term life insurance life insurance (death) cover

¶7-100

tax implications for death cover

¶7-150

Termination of employment — see also Genuine redundancy and early retirement scheme assessable income

¶1-265

employment termination payments

¶1-285

Testamentary gifts CGT exemption

¶19-160

charitable bequests

¶19-755

cultural bequests

¶19-760

Testamentary trusts

¶13-615

estate income

¶19-850

estate planning

¶19-165

estate planning for children

¶13-915

income and asset tests tax rates Thin capitalisation gearing foreign investments Total and permanent disability (TPD) insurance

¶6-620 ¶19-855 ¶1-560 ¶11-230

bundled or linked TPD

¶7-220

definition

¶7-200

stand-alone policy

¶7-220

tax implications

¶7-230

TPD, definition

¶7-210

Total superannuation balance contributions to superannuation funds — calculation

¶4-233

— significance

¶4-233

Trading stocks capital gains and losses deductions effect of death

¶2-110; ¶2-270; ¶2-520; ¶4-320 ¶1-300 ¶19-805

Transfer balance account superannuation income stream

¶4-228

Transfer balance cap contributions to superannuation funds — commutation authorities

¶4-230

— debits

¶4-228

— defined benefit income streams

¶4-232

— excess transfer balance determinations

¶4-230

— excess transfer balance tax

¶4-231

— retirement phase recipient

¶4-228

— superannuation income stream in retirement phase

¶4-228

— transfer balance account

¶4-228

death benefit from income streams

¶16-940

— impact of child pension

¶16-930

retirement incomes — starting an income stream — assessment against transfer balance cap

¶16-155

— capped defined benefit income streams

¶16-180

— commencement

¶16-150

— tax on excess amount

¶16-170

taxation of death benefit income stream — interaction Transfer or trusts

¶16-910

assessable income of residents

¶1-550; ¶1-570

Transfer pricing

¶1-615

Transition to retirement income stream (TRIS)

¶4-228

retirement portfolio construction — non-commutable income streams

¶16-585

taxation of pensions and the transfer balance cap

¶16-585

transition to retirement and salary sacrifice strategy

¶16-610

Trauma insurance definition

¶7-250

tax implications for trauma cover

¶7-270

trauma claim events

¶7-250

Travelling expenses Trowbridge report

¶12-068 ¶7-990

Trust deeds self managed superannuation funds — establishment — investments Trust splits

¶5-100 ¶5-300; ¶5-310 ¶2-110

Trustees deceased estates — appropriation of assets for beneficiary

¶19-670

— asset distribution

¶19-505

— “after-acquired asset”

¶19-675

— duties and powers

¶19-510

— executors

¶19-050

— restricted trusts

¶19-305

income tax — see Trusts self managed superannuation funds

¶5-020

— annual returns

¶5-225

— directed investment strategy

¶5-220

— duties

¶5-110

— market value reporting

¶5-210

— member accounts

¶5-200

— obligations

¶5-050

— Trustee Declaration

¶5-100

superannuation entities — family breakdown — taxable income

¶18-205 ¶1-050

trust deed, SISA and investments — borrowing in limited circumstances

¶5-360

Trusts acquisition of family home

¶12-100

Age Pension entitlements

¶19-275

assessable income

¶1-280

attribution managed investment trusts

¶2-215

avoiding CGT by exploiting restructure rollover

¶2-650

business succession

¶19-800

CGT — avoidance using a trust structure

¶2-650

— beneficiaries

¶2-360

— capital gains or losses

¶2-220

— CGT events

¶2-110

— restructuring

¶2-410

— special disability trusts (SDTs)

¶2-250

— topical checklist

¶2-700

children's income — issues for trustees

¶13-620

— social security implications

¶13-625

deceased estate asset distribution

¶19-505

definition

¶1-500

employee share trust schemes

¶3-430

family breakdown — child maintenance trusts — discretionary trusts

¶18-450 ¶13-810; ¶18-715 ¶18-615–18-625

FBT — employment remuneration trust arrangements

¶3-430

income tax

¶1-500

— beneficiary presently entitled

¶1-510

— beneficiary under legal disability

¶1-515

— deductible losses

¶1-525

— no beneficiary presently entitled

¶1-520

— trust income or losses

¶1-505

instalment trusts

¶2-220

managed investment trusts

¶2-215

net capital gain/franked distribution

¶2-360

private trusts and companies — income and assets test

¶6-620

— special disability trusts

¶6-620

rules about capital gain and beneficiaries

¶2-215

12-month exemption

¶10-350

Type 1 gross-up rate

¶3-155; ¶3-300; ¶3-950

Type 2 gross-up rate

¶3-155; ¶3-300; ¶3-900

U Unclaimed money online investing

¶21-180

Undeducted superannuation contributions — see Excess non-concessional contributions Underinsurance in Australia

¶7-070

Underwriting financial

¶7-410

medical

¶7-410

Unearned income children — income tax

¶1-070; ¶13-615

Unfair contract terms consumer protection

¶8-410

Uniform Consumer Credit Code (UCCC)

¶8-410

Unit trusts

¶9-450

assessable income

¶1-270

CGT

¶2-110

— options

¶2-355

— topical checklist

¶2-700

home loan unit trust schemes income tax

¶12-100 ¶1-500

return of capital

¶2-205

self managed superannuation funds — widely held unit trusts

¶5-330

Unrestricted non-preserved benefits — see Superannuation funds Unsecured loans borrowing

¶11-330

Unused leave entitlements annual leave

¶20-115

deceased estates

¶19-625

genuine redundancy, early retirement scheme or invalidity — annual leave

¶14-230

— long service leave

¶14-240

invalidity

¶14-310

long service leave

¶20-120

payments in lieu

¶1-265

— income maintenance period

¶6-730

social security issues

¶14-430

US securities online investing

¶21-720

V Variable interest property loans and margin lending

¶11-400

Venture capital investments carried interest payments

¶2-110

VET FEE-HELP

¶13-410

VET student loans

¶13-410

Veterans’ Affairs Benefits — see Department of Veterans’ Affairs (DVA) benefits Visiting overseas employees salary packaging

W Wages and salary — see Salary and wages

¶10-670

Waiting periods — see also Specific types business expenses insurance

¶7-610

income protection

¶7-340

insurance policy — claims process

¶7-975

social security — compensation

¶6-710

— income maintenance period

¶6-730

— liquid assets

¶6-720

— newly arrived residents

¶6-750

— ordinary waiting period

¶6-705

— rules

¶6-700

War Veterans’ Benefits — see Department of Veterans’ Affairs (DVA) benefits War Widow/er Pension

¶6-460

Income Support Supplement

¶6-460

Warrants endowment warrants

¶11-750

instalment warrants

¶9-340; ¶11-700

investment warrants

¶9-340

online investing

¶21-820

trading warrants

¶9-340

Websites — see Online investing Wholesale client advice interest obligation

¶8-240

retail clients

¶8-240

wholesale/sophisticated investors

¶8-240

Wholesale clients

¶8-240

Wholly-owned group of companies tax consolidation regime Widow Allowance

¶1-400 ¶6-270; ¶20-540

Wife Pension exemptions

¶6-135

Wills

¶19-030

account-based pensions or annuities

¶19-110

adjustment of beneficiary entitlements

¶19-115

application of rules to different types of entitlements

¶19-650

— annuities

¶19-665

— asset acquired under an option

¶19-685

— asset sold to beneficiary

¶19-680

— assets appropriated by trustee for beneficiary

¶19-670

— assets previously held by joint tenants

¶19-695

— contingent gifts

¶19-660

— disclaimed interests

¶19-715

— entitlement under discretionary trust

¶19-700

— “improved” asset

¶19-690

— legacies

¶19-655

— life estates

¶19-710

— property subject to mortgage

¶19-705

appointment of guardians

¶19-055

CGT and deceased estates

¶19-150–19-165

codicil

¶19-085

content of funeral service

¶19-080

contesting

¶19-090

— asset distribution

¶19-520

discretionary life interest

¶19-075

discretionary trusts

¶19-200–19-275

— non-estate assets

¶19-360

disposal of body

¶19-080

distribution of estate assets

¶19-505

distribution of personal chattels

¶19-065

estate planning objectives

¶19-035

executors

¶19-050

— asset distribution

¶19-505

— duties and powers

¶19-510

family breakdown

¶18-020; ¶19-085

family provisions

¶19-095

fixed life interest

¶19-070

funeral arrangements

¶19-080

gifts to beneficiaries

¶19-060

gifts to tax-exempt organisations

¶19-160

homemade

¶19-045

intestacy

¶19-047

jointly owned assets

¶19-355

legal requirements

¶19-045

— mental illness and testamentary capacity

¶19-045

life insurance

¶19-370

marriage and/or divorce, effect

¶19-085

non-estate assets ownership of assets probate restricted trusts

¶19-350–19-370 ¶19-040 ¶19-100; ¶19-505 ¶19-300–19-315

review and update

¶19-085

special requests

¶19-080

superannuation benefits

¶19-365

testamentary capacity

¶19-045

testamentary trusts

¶19-165

— estate planning for children

¶13-915

trustee's duties and powers

¶19-510

Withholding tax CGT — clearance certificate

¶12-070; ¶12-071 ¶12-072

collection — see PAYG withholding exclusions

¶1-150

non-resident CGT withholding

¶1-295

rates

¶1-150

Work Bonus

¶6-540

Age Pension

¶6-140

Work-from-home during COVID-19 special shortcut provisions

¶8-265; ¶12-060 ¶1-320

Work-related equipment and tools salary packaging

¶10-520

Work-related expenses deductions

¶1-320

FBT exempt benefits

¶3-600

home office

¶12-068

Work test exemptions

¶4-205

Workers compensation social security benefits

¶6-710

Working hours reduction due to COVID-19

¶6-190

Wrap accounts

¶9-430

Y Yield — see Returns Yield curve investments Youth Allowance

¶9-170 ¶6-050; ¶6-250; ¶13-745

family financial planning — eligibility

¶13-745

NARWP

¶6-750

ordinary waiting period

¶6-705